• The average share price over the year was $3.00. Required : (a) Compute the basic EPS amount for X2. (b) Compute the diluted EPS amount for X2. Calculating earnings for basic EPS : Reported after tax net income $800,000 less : Pref share divs (400,000 x $1 x 10%) 40,000 Op profit after tax less pref divs $760,000
7 of 9 Calculating weighted average number of ordinary shares and ordinary share equivalents: Weighted Total Conversion Weighted Av Dates Av # Days # Shares Factor No. Shares Fully paid ordinary shares 1/7/X1-31/10/X1 123/365 400,000 134,794 1/11/X1-30/6/X2 242/365 500,000 331,507 Partly-paid ordinary shares 1/7/X1-30/6/X2 365/365 100,000 0.60/1.50 40,000 Total wtd av number of ord shares 506,301 Basic EPS for X2 = $760,000 = $1.50 506,301 Test the potential ordinary shares to see if they are dilutive: Convertible preference shares - If the preference shares were converted, then no preference share dividend would be paid. Therefore, the preference share dividend is not subtracted in determining diluted EPS. - Therefore, the notional after tax earnings adjustment is $40,000. - The number of ordinary shares outstanding would be increased by the number of ordinary shares that the preference shares can be converted into. - Therefore, the adjustment for potential ordinary shares is 100,000. - EPS effect = $40,000 = $0.40 100,000 - As EPS Effect < Basic EPS the convertible cumulative preference shares are dilutive. Convertible debentures - If the debentures were converted the interest expense (after tax) would not have been subtracted from earnings. Therefore, the interest expense (after tax) is added back. - Therefore, the notional after tax adjustment is: $1,000,000 x 8% x (273/365) x (1 - 0.40) = $35,901 - The debentures were issued during the year, so the potential ordinary shares will be weighted for the period outstanding if they are dilutive. The number of ordinary shares
8 of 9 outstanding would be increased by the number of ordinary shares that the debentures can be converted into, weighted by the number of days outstanding. - Therefore, the potential ordinary shares are: 200,000 x (273/365) = 149,589 - EPS effect = $35,901 = $0.24 149,589 - As EPS Effect < Basic EPS, the convertible debentures are dilutive. Partly-paid shares - As the directors believe that a call on the partly-paid shares would be successful, they are considered to be dilutive potential ordinary shares even if they cause EPS to increase. - Funds received from call: = 100,000 x (1.50 - 0.60) = $90,000 - These funds could have purchased 30,000 shares at the average market price (90,000/3) - However, the potential ordinary shares that would result from the conversion is 60,000 (100,000 - 40,000) - Therefore, in effect, 30,000 shares are deemed to be issued for no consideration (60,000 – 30,000) - Partly paid shares are considered dilutive and must be included in the calculation of diluted EPS Calculate diluted EPS including potential shares from partly paid shares : Diluted EPS = $760,000 + 0 = $1.42 506,301 + 30,000 THIS IS OUR STARTING POINT! Calculate diluted EPS including potential shares from partly paid shares & debentures : Diluted EPS = $760,000 + 0 + 35,901 = $1.16 506,301 + 30,000 + 149,589 As this EPS is less than Basic EPS of $1.42, potential shares from the conversion of debentures are considered dilutive.
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- Summer '19
- Corporate Finance, Dividend, Merck, ordinary shares, Basic EPS, random walk model