Vol. 3 LM1 EPS

Question 1

A company’s ____ is composed of its equity and debt.

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Answer 1

capital
* some types of equity have preference over others, and
* some debt (and other instruments) may be converted into equity

Question 2

Describe

ordinary shares

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Answer 2

• are those equity shares that are subordinate to all other types of equity.
• The ordinary shareholders are basically the owners of the company

Question 3

Concept

these shareholders are paid last in a liquidation of the company, but provide the most benefit when the company is doing well

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Answer 3

ordinary shares

Question 4

Under US GAAP

ordinary equity is referred to as

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Answer 4

common stock or common shares
* “ordinary shares”, “common stock”, and “common shares” are used interchangeably

Question 5

Define

warrant

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Answer 5

is a call option typically attached to securities issued by a company, such as bonds

Question 6

mechanics

warrant

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Answer 6

gives the holder the right to acquire the company’s stock from the company at a specified price within a specified time period

Question 7

Define

basic EPS

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Answer 7

is the amount of income available to common shareholders divided by the weighted average number of common shares outstanding over a period

Question 8

formula

basic EPS

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Answer 8

Basic EPS = (Net income - Preferred dividends) / (weighted average number of shares outstanding)

Question 9

reason

accounting standards require companies to disclose what their EPS would be if all dilutive financial instruments were converted into common stock.

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Answer 9

information about potential dilutions are valuable to both current and potential shareholders

Question 10

Concept

The result if all dilutive financial instruments were converted is called

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Answer 10

diluted EPS

Question 11

True or false

companies are required to report basic and diluted EPS as well as amounts for continuin operations

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Answer 11

true

Question 12

Calculate weighted average

assume a company began the year with 2,000,000 common shares outstanding and repurchased 100,000 common shares on 1 July.

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Answer 12

1,950,000 shares outstasnding
* Jan 1: 2,000,000
* July 1: 2,000,000-100,000 (repurchased)
* 2,000,000(0.5)+1,900,000(0.5)

Question 13

basic EPS calculation

For the year ended 31 December 2018, Shopalot Company had net income of $1,950,000. The company had 1,500,000 shares of common stock outstanding, no preferred stock, and no convertible financial instruments.

What is Shopalot’s basic EPS?

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Answer 13

basic EPS = $1,950,000/1,500,000 shares = $1.30

Question 14

basic EPS calculation

or the year ended 31 December 2018, Angler Products had net income of $2,500,000. The company declared and paid $200,000 of dividends on preferred stock. The company also had the following common stock share information:

Shares outstanding on 1 January 2018 1,000,000
Shares issued on 1 April 2018 200,000
Shares repurchased (treasury shares) on 1 October 2018 (100,000)
Shares outstanding on 31 December 2018 1,100,00

weighted average number of shares outstanding?

Answer 14

1,000,000x(3 months/12 months) = 250,000
* April - Jan

(1,000,000+200,000)x(6 moths/12 months) = 600,000
* October 1 - April 1

(1,200,000-100,000)x(3 months/12months) = 275,000
* Dec 31 - Oct 1

250,000+600,000+275,000=1,125,000

Question 15

basic EPS calculation

or the year ended 31 December 2018, Angler Products had net income of $2,500,000. The company declared and paid $200,000 of dividends on preferred stock. The company also had the following common stock share information:

Shares outstanding on 1 January 2018 1,000,000
Shares issued on 1 April 2018 200,000
Shares repurchased (treasury shares) on 1 October 2018 (100,000)
Shares outstanding on 31 December 2018 1,100,00

basic EPS?

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Answer 15

Basic EPS = (net income - preferred dividends)/weighted average # of shares
* (2,500,000-200,000)/1,125,000=$2.04

Question 16

basic EPS calculation

Assume the same facts as Example 7 except that on 1 December 2018, a previously declared 2-for-1 stock split took effect. Each shareholder of record receives two shares in exchange for each current share that he or she owns.

What is the company’s basic EPS?

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Answer 16

For EPS calculation purposes, a stock split is treated as if it occurred at the beginning of the period. The weighted average number of shares would, therefore, be 2,250,000, and the basic EPS would be $1.02 [= ($2,500,000 –$200,000)/2,250,000].

Question 17

When a company has convertible preferred stock outstanding, diluted EPS is calculated using…

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Answer 17

if-converted method

Question 18

describe

if-converted method

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Answer 18

is based on what EPS would have been if the convertible preferred securities had been converted at the beginning of the period.

Question 19

if-converted method for preferred stock

diluted EPS

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Answer 19

Diluted EPS = [ net income / ( weighted average number of shares + new common shares that would have been issued at conversion) ]

Question 20

Diluted EPS Calculation Using If-Converted Method

for Preferred Stock

• FYE 31 December 2018, company had net income of $1,750,000.
• average of 500,000 shares of common stock outstanding,
• 20,000 shares of convertible preferred,
• and no other potentially dilutive securities
• Each share of preferred pays a dividend of $10/share, and each is convertible into five shares of common stock.

Calculate basic EPS and diluted EPS

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Answer 20

• under basic and diluted if-converted, net income $1,750,000
• preferred dividend

Question 21

when a company has stock options, warrants, or their equivalents outstanding, diluted EPS is calucation as if

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Answer 21

the financial instruments had been exercised and the company had used the proceeds from exercise to repurchase as many shares of common stock as possible at the average market price of common stock during the period

Question 22

Concept

the weighted average number of shares outstanding for diluted EPS is thus increased by the numer of shares that would be issued upon exercise minus the number of shares that would have been purchased with the proceeds

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Answer 22

treasury stock method

Question 23

Describe

Diluted EPS under treasury stock method

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Answer 23

For the calcuation of diluted EPS using this method, the assumed exercise of these financial instruments would have the following effects
* The company is assued to received cash upon exercise and, in exchange, to issue shares
* The company is assumed to use the cash proceeds to repurchase shares at the weighted average market price during the period

Question 24

Under the treasury stock method

if the financial instrument was issued prior to the beginning of the year

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Answer 24

the weighted average number of shares outstanding increases by the incremental number of shares

Question 25

under the treasury stock method

if the financial instruments were issued during the year,

Answer 25

then the incremental shares are weighted by the amount of time the financial instruments were outstanding during the year.

Question 26

calculate

diluted EPS treasury stock method

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Answer 26

diluted EPS =
numerator: net income - preferred dividends
denominator: [weighted average number of shares outstanding + (new shares that would have been issued at option exercise) x (proportion of year during which the financial instruments were outstanding)]

Question 27

Describe

antidilutive

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Answer 27

their inclusion in the computation would result in an EPS higher than the company’s basic EPS

Question 28

Complete the statement

Diluted EPS should reflect

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Answer 28

the maximum potential dilution from conversion or exercise of potentially dilutive financial instruments

Question 29

fill in the blank

Diluted EPS will always be ____ to basic EPS

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Answer 29

less than or equal