Fall 2010 Class 5

Fall 2010 Class 5 - CHAPTER 17 Earnings per Share (EPS)...

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Unformatted text preview: CHAPTER 17 Earnings per Share (EPS) Questions We Need to Answer Questions We Need to Answer 1. Why Earnings per share (EPS) is an Why important number? important 2. What are GAAP requirements on reporting What EPS? EPS? 3. How to calculate basic EPS and diluted How EPS? Importance of EPS Importance of EPS • Calculated for common shares Calculated common • Tells shareholders how much of the available Tells income is associated with the shares they own income • Provides insight to shareholders – Future dividend payout – Future share value – Impact of other financial instruments on Impact their potential earnings (Diluted EPS) their Basic EPS vs. Diluted EPS Basic EPS vs. Diluted EPS • Basic EPS – Actual earnings and actual number of issued actual common shares common • Diluted EPS – Earnings and number of common shares adjusted Earnings for “what-if” for • What would the EPS be if any financial instruments What that could be converted to common shares were converted converted EPS Calculation EPS Calculation Income available to common Income shareholders shareholders EPS = Weighted average number of common shares common EPS Disclosure EPS Disclosure • IAS 33 requires EPS to be reported as part of IAS the income statement the • Reported for each income component as Reported each reported on the income statement reported • If the firm has complex capital structure, both If complex both Basic EPS and Diluted EPS reported Basic • Presented for all periods reported Presented all EPS Reporting Requirements EPS Reporting Requirements Capital Capital Structure Structure Major Types of Equity Major Instruments Instruments Impact on EPS Impact Calculations Calculations Simple Common shares Preferred shares Basic EPS only Complex Common shares Basic and Basic Diluted EPS Diluted Potential Common shares: –Convertible preferred shares –Convertible debt –Options/warrants –Contingently issuable EPS ­ Simple Capital Structure EPS ­ Simple Capital Structure Net Income – Preferred Dividends Net Preferred Weighted Average # of Shares Outstanding • If the preferred shares are non-cumulative non-cumulative – include only declared dividends declared • If the preferred shares are cumulative cumulative – include only declared dividends, or declared – iif no dividends declared, include only one year’s f dividends dividends EPS – The Numerator EPS Example: Michael Limited • Net Income $3,000,000 • Shares – 100,000 Class A preferred, cumulative shares, 100,000 cumulative dividend amount $4.00 per share dividend – 100,000 Class B preferred, non-cumulative 100,000 non-cumulative shares, dividend amount $3.00 per share shares, • No dividends declared or paid in the current year and the previous year. year EPS – The Numerator EPS Net Income $3,000,000 Amount attributable to Class A: 100,000 x $4.00 400,000 100,000 2,600,000 2,600,000 Amount attributable to Class B: 100,000 x $0.00 -0100,000 Income available to common shareholders $2,600,000 common $2,600,000 The Class B shares are non-cumulative, with no dividends The declared for the year no amount is deducted from Net Income declared EPS – The Denominator EPS Net Income – Preferred Dividends Weighted Average # of Shares Outstanding • Number of shares issued is weighted by the Number period of time they were outstanding period • Each transaction (issue of shares, Each reacquisition of shares, retirement of shares) represents a weighting period represents EPS – The Denominator EPS Date Share Changes Shares Dates Shares Dates Outstanding Outstanding Outstanding Outstanding 90,000 ? Jan. 1 Beginning balance April 1 30,000 shares 30,000 issued issued 120,000 ? July 1 39,000 shares 39,000 purchased purchased 81,000 ? Nov. 1 60,000 shares 60,000 issued issued 141,000 ? Dec. 31 Year end balance 141,000 -- EPS – The Denominator EPS Dates Outstanding Shares Shares Outstanding (A) Outstanding Fraction Weighted Shares Portion of Year Portion Outstanding (B) Outstanding Weighted Weighted Shares (A*B) (A*B) 3 months 90,000 3/12 22,500 3 months 120,000 3/12 30,000 4 months 81,000 4/12 27,000 2 months 141,000 2/12 23,500 Weighted Average Shares Outstanding 103,000 EPS – The Denominator EPS • Stock splits and stock dividends require restatement of the outstanding number of shares restatement from the beginning of the year from – Because there has been no change in the Because company’s assets, or in the shareholders’ total investment investment EPS – The Denominator EPS Date Share Changes Jan. 1 Beginning balance April 1 30,000 shares issued July 1 39,000 shares 39,000 purchased, and 2 for 1 stock split stock Nov. 1 60,000 shares issued Dec. 31 Year end balance Shares Dates Shares Dates Outstanding Outstanding Outstanding Outstanding 90,000 3 months 120,000 3 months 81,000*2 81,000*2 =162,000 4 months 162k+60k =222,000 2 months 222,000 -- EPS – The Denominator EPS Dates Dates Outstanding Outstanding Shares Outstanding (A) Fraction Weighted Shares Portion of Year Portion Outstanding (B) Outstanding Weighted Weighted Shares (A*B) (A*B) 3 months 90,000*2=180,000 3/12 45,000 3 months 120,000*2=240,000 3/12 60,000 4 months 81,000*2=162,000 4/12 54,000 2 months 162,000+60,000=222,000 2/12 37,000 Weighted Average Shares Outstanding 196,000 EPS – The Denominator • If there is a stock split or stock dividend after the year end but before the publication of the financial statements financial statements • The weighted average number of shares The outstanding must be restated outstanding • This applies to the current year, as well as This current as previous years if comparative statements are previous issued issued EPS Reporting Requirements EPS Reporting Requirements Capital Capital Structure Structure Major Types of Equity Major Instruments Instruments Impact on EPS Impact Calculations Calculations Simple Common shares Preferred shares Basic EPS only Complex Common shares Basic and Basic Diluted EPS Diluted Potential Common shares: –Convertible preferred shares –Convertible debt –Options/warrants –Contingently issuable Diluted Earnings per Share ­ Diluted Earnings per Share ­ Methods • The dilutive effect of convertible securities is The convertible measured by the if-converted method if-converted • For computing dilution, the rate of conversion For most advantageous to the security holder is used most (maximum dilutive conversion rate) (maximum • The dilutive effect of options and warrants is options measured by the treasury stock method or reverse treasury stock method reverse If­Converted Method (1) If­Converted Method (1) • Step 1: Anti-dilutive Test – Anti-dilutive instruments will be excluded Anti-dilutive from the calculation of diluted EPS. from – A convertible debt or a convertible preferred convertible share is anti-dilutive if EPS after conversion is higher than EPS before conversion higher If­Converted Method (2) If­Converted Method (2) • Step 2: Re-calculate Income available to common shareholders shareholders – Convertible debt • Income is adjusted for the after-tax interest Income after-tax expenses that would not have been recognized if the debt were converted to common shares the – Convertible preferred shares • No adjustment to the net income if there are convertible preferred shares convertible If­Converted Method (3) If­Converted Method (3) • Step 3: Re-calculate weighted average Step number of shares number – Adjusted as if all convertible securities were Adjusted converted to common shares at the beginning of the year or at the issuing date at • Step 4: Calculate Dilutive EPS If­Converted Method­Example If­Converted Method­Example • • • Net income:=$210,000; Weighted average number of common shares outstanding=100,000; Basic EPS=$1.8 Three convertible bonds outstanding: • $1M, 10% bond, issued at par in a prior year, convertible into 10,000 common shares. • $1M, 6% bond, issued at par on April 1 of the current year, convertible into 40,000 common shares. • 10,000 $3 convertible preferred shares, issued for 1M on April 1 of the current year, convertible into 40,000 common shares. Tax rate: 40% Step 1:Anti­dilutive Test Step 1:Anti­dilutive Test Anti-dilutive Test (Basic EPS=$1.8) Interests/Dividends Saved Number of Shares Increased Incremental EPS 10% Bond 1M*10%*(1-40%)=60,000 10,000 $6 Anti-dilutive 6% Bond 1M*6%*9/12*(1-40%)=27,000 40,000*9/12=30,000 $0.9 Dilutive $3 Pref. Shares 30,000 40,000*9/12=30,000 $1 Dilutive Step 2: Re­calculate Income available Step 2: Re­calculate Income to common shareholders Net Income for the Year Add back: Interest saved on 6% bonds 1M*6% x 9/12 x (1-40%) 1M*6% (1-40%) Adjusted Net Income $210,000 $27,000 $27,000 $237,000 Step 3: Re­calculate weighted Step 3: Re­calculate weighted average number of shares Unadjusted Weighted Average Number of Shares 100,000 Add: Shares assumed issued (converted) 6% debentures (as of date of issue) 30,000* (as $3 pref. shares (as of date of issue) 30,000* (as 30,000* Weighted Average Number of Shares 160,000 *30,000=9/12x40,000 Step 4: Diluted EPS= $237,000/160,000=$1.48 The Treasury Stock Method The Treasury Stock Method • Used with written call options when they are dilutive Used call dilutive • A written call option is dilutive when the exercise price is written less than the market price. less • Options and warrants are assumed exercised at the Options beginning of the year beginning • The proceeds from the exercise of options are assumed The to be used to buy back common shares buy Options and Warrants ­ Options and Warrants ­ Treasury Stock Method Given: • Exercise price of a written call option (for one share of Exercise stock) $ 30 30 • Average market price of one share during the year: $ 50 market 50 • Options deemed exercised: 1,500 1,500 • Compute the number of weighted shares for determining Compute diluted earnings per share Calculation: Total proceeds from exercise (1,500*$30): $45,000 Total $45,000 Shares issued on exercise: 1,500 Shares 1,500 Assumed reacquisition of shares ( $45,000/$50): 900 ): 900 Dilution: 1,500 - 900 = 600 Shares (increase in outstanding shares) Reverse Treasury Stock Method Reverse • Used with written put options when they are dilutive Used put dilutive • A written put option is dilutive when the exercise price written put is higher than the market price. higher • Options and warrants are assumed exercised at the Options beginning of the year. beginning • The firm is assumed to issue new shares to generate The enough funds to buy the shares from the option holder when the put option is exercised. Reverse Treasury Stock Method Reverse Given: Exercise price of a written put option (for one share of stock) : $ 30 30 Average market price of one share during the year: $ 20 Average 20 Options deemed exercised: 1,500 Options 1,500 Compute the number of weighted shares for determining diluted earnings per share Calculation: Amount needed to buy back the 1,500 shares: Amount (1,500 * $30) $45,000 Shares issued to acquire needed cash: Shares ( $45,000 ÷ $20) 2,250 $45,000 $20 2,250 Number of shares purchased through option: 1,500 Number 1,500 Dilution: 2,250 – 1,500 = 750 Shares 750 (increase in outstanding shares) Case for next week Case for next week • CA17-1. CA17-1. • Question of the case will be changed Question to: to: “If you were a shareholder of CP, what If shareholder is your analysis of the situation described, and how would you react to CP’s plan to exchange the convertible notes?” About Mid­Term About Mid­Term • Structure: Structure: – 12 Multiple Choices, 36% – 3 Problems, 64% • Time and Location: Time Evening: Oct. 27, AQ3003 Evening: Day: Oct. 28, WMX2220 • Coverage: Chapter 13 to Chapter 17 ...
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