anyone know how to do this question For the year ended 12/31/2013, Stack reported Net Income of $25,000. On 1/1/2013, Stack had 22,000 common shares outstanding and 10,000 preferred shares outstanding. Stack issued 4,000 common shares on 6/30/2013. Stack paid $5,000 of preferred dividends and $9,000 of common dividends during 2013. During fiscal year 2013, Stack had 10,000 outstanding in-the-money options with an average exercise price of $10. The average stock price during the year was $20. Calculate the diluted EPS. a. $1.04 b. $0.83 c. $0.69 d. $0.78
1. Calculate Basic EPS.
Basic EPS = (Net income-Preferred dividends)/ Weighted average number of common shares outstanding during the year
Net income = $ 25 000
Preferred dividends = $ 5 000
W.a.n.o.c.s.o = 24 000 shares
a) 22 000 shares * 12 months (from 1/1/2013 till 12/31/2013) = 264 000 shares
b) 4 000 shares * 6 months = 24 000 shares
Average = (264 000 +24 000)/12 months = 24 000 shares
Basic EPS = ($25 000 - $5000) / 24000 shares = $0,83 per share. Diluted EPS can’t be higher than Basic EPS, so option A is definitely wrong.
2. Preferred stock dilutive effect
There is no indication that preferred stock is convertible to common stock. Consequently, no dilutive effect.
3. Stock options dilutive effect
If holders of stock options decided to convert their options into shares, the company would issue 10 000 new stocks at 10 $ per share.
Proceeds from the shares issued = $10 * 10 000 new shares = $100 000
The company can buy back 100 000/20 = 5000 shares (at market price).
Net shares created = 10 000 - 5000 = 5000.
Diluted EPS = ($25 000 - $5000)/(24000 shares + 5000 shares) = $0,69 per share (less than Basic EPS).
Correct answer is C.
In a more simple version.
[(Net Income) 25,000 - 5000 (Preferred Shares Dividend)]
Total Numerator = 20,000
Denominator for Basic EPS = (Common Oustanding (22,000 * 12/12) 22,000 + 2,000 [Additional Common Issue = 4,000*(6/12)]
Total Demonimator = 24,000.
Basic EPS = (25,000 - 5,000) / 24,000 = 0.833
For Diluted EPS
You need to convert the options on Common stock.
Additional Common Stock to be outstanding = (Average Stock price - Excercise Price) / Average Stock price
= (20-10)/20 = 0.5
Additional Common Stock Outstanding = (stock option) 10,000 * 0.5 = 5,000.
Diluted EPS = (25,000 - 5,000) / (24,000 + 5,000) = 0.6897 or 0.69
Thus Option C is correct.
The question or the trick or the rule of thumb is for us to know criteria used in determining whether a convertible, or warrants, or options are dilutive
Just see which security/instrument is convertible.
In this case, only the stock options are the only dilutive instruments. Preferred Stock are non-convertible. Thus they have no dilution effect.
I must share with you people another thing here. Since calculating EPS is easy, I do it before calculating the Diluted EPS. Why you ask? Because if there is any anti dilution the basic EPS will be our Diluted EPS. So, even if you calculate the correct diluted EPS, if its anti dilutive (higher than the basic EPS even after dilution effect) than the correct answer will be going with the basic EPS.
So, in questions where we are asked to calculate the diluted EPS, we must also calculate the basic EPS in order to compare our answer with the basic EPS.