# Diluted EPS

Philpott Co. had 1,200,000 common shares outstanding on January 1 and December 31, 2002. In connection with the acquisition of a subsidiary company in June 2001, Philpott is required to issue 50,000 additional common shares on July 1, 2003, to the former owners of the subsidiary. Philpott paid \$300,000 in preferred shares dividends in 2002, and reported net income of \$5,100,000 for the year. Philpott’s diluted earnings per share for 2002 should be: A. \$4.25. B. \$4.08. C. \$4.00. D. \$3.84.

c?

I got C as well

C (5,100,000 - 300,000) / 1,200,000 The 50,000 shares wouldn’t be dilutive until actually issued in 2003. Right?

C EPS = (5100K - 300K)/1200K = 4800K/1200K = 4 - Dinesh S

budfox, yeah that’s what I thought. They’re asking for the diluted EPS in 2002.

C

D. Since the company was acquired in 2001 i think the 50000 additional shares should figure in the calculations even though it is not required to actually issue till 2003 (kind of like a stock option) .

sv102307 Wrote: ------------------------------------------------------- > D. Since the company was acquired in 2001 i think > the 50000 additional shares should figure in the > calculations even though it is not required to > actually issue till 2003 (kind of like a stock > option) . Stock options don’t figure into the dilution until the average price for the period exceeds the excercise price.

The correct answer is D. \$3.84.

but why D… Can someone explain pls?

Contingent shares that are issuable only based on the passage of time are included in shares outstanding. The question doesn’t give much information, but you can assume that the former shareholders don’t have to do anything to receive the additional shares. Therefore, the shares outstanding for the year is 1,250,000.

where did this ? come from?

Wow, what a question! Absolutely, that’s what diluted EPS is all about. I didn’t get it at first, but I agree with the answer now. When it is already known that additional shares will be issued as a matter of time, then analysts should assume the EPS to be based on the new shares. The only question is that there should be a time limit for when to consider the shares in the diluted EPS. It is definietly not reasonable to calculate diluted EPS, in this example, if the shares were to be issued 10 years later, for example. Good question

a practice exam question from analyst notes. Thanks Dreary for the explanation!

budfox427 Wrote: ------------------------------------------------------- > sv102307 Wrote: > -------------------------------------------------- > ----- > > D. Since the company was acquired in 2001 i > think > > the 50000 additional shares should figure in > the > > calculations even though it is not required to > > actually issue till 2003 (kind of like a stock > > option) . > > > Stock options don’t figure into the dilution until > the average price for the period exceeds the > excercise price. From stuartma10’s post, i think the term i was searching for was contingent shares. The CFAI notes had a similar example (except in that case the shares were to be issued when the subsidiary got a certain income level). I kind of classified it mentally as a stock option with a zero exercise price (I do not have a finance background as you can probably tell ) Also to my mind, calculation of diluted EPS is all about whether something has the potential to change the EPS in the future. If it does, it should be factored in the calculation.

I was juggling between C and D and then a coin toss made me go C’ish Actually, my bad… US GAAP is all about Law of conservatism (Atleast, that’s what I could judge after reading the FSA). If you foresee things happening, consider it has happened and account for it. Likewise, if you foresee some losses, account for it right away… (Same is NOT true for gains foreseen…) but of course experts would be better able to comment on this? All in all a good question. - Dinesh S

Dinesh - US GAAP does use the principle of conservatism, but it also advocates accuracy. Making some assumptions, I am going to outline why I think this answer/question is bogus. Company A makes \$100 from 1/1/07 though 12/31/07. There are 100 shareholders at 12/31/07; each holding one share of common stock. Company A distributes all earnings in dividends to shareholders on 1/1/08 (each shareholder recieves distribution of \$1). Company A is required to issue 100 shares of stock on 5/31/08 (just like in the original question above). This information is known 1/1/07. What is dilutive EPS for 2007? I would champion: 100/100 = \$1 EPS is supposed to approximate the earnings generated that could be distributed to shareholders, right? Each shareholder @ 1/1/08 received \$1. Regardless of whether or not we know more shares will be available, the shareholders of new shares will not have claim to the \$100 earned in 2007. This is why I think: 100/200 = .50 is incorrect. I think this question is bogus. Other thoughts?

yeah, I think it is bunk. I’ve been through all the Schweser tests, tons of Qbank, and some of book 7 and some CFAI online, and I have never seen a question like that or an outcome like that. At all.

ٍIt makes a lot of sense if you know the purpose of diluted EPS very well.