Diluted EPS

Selected information from Gerrard, Inc.’s financial activities in the year 2004 was as follows: Net income was $330,000. The tax rate was 40 percent. 700,000 shares of common stock were outstanding on January 1. The average market price per share was $6 in 2006. Dividends were paid in 2006. 2,000 shares of 8% $500 par value preferred shares, convertible into common shares at a rate of 200 common shares for each preferred share, were issued in 2005. 200,000 shares of common stock were issued on March 1. Gerrard, Inc.’s diluted earnings per share (diluted EPS) was closest to: A) $0.289. B) $0.261. C) $0.197. D) $0.254. Guys help me… am i missing something here… i chose A as there is no dilutive security for 2004…

bro, look at the word convertible in the question, this has a complex capital structure if you see that word, and therefore, is potentially diultive to EPS

but preferred were issued in 2005 not 2004. is it a typo… i didnt find anything in Errata…

First calculate the number of shares outstanding in 2006 (I bet the 2004 in the question is in fact 2006): 700,000 outstanding as of January 1, and 200,000 issued at march 1, the number of common shares outstanding would be 700*2/12+(700+200)*10/12 = 866.67~867,667 shares of common stock. Calculate the preferred dividends = 2000*500*8% = 80,000 Calculate the Basic EPS = (NI-Pref Div)/# of shares outstanding = (330,000-80,000)/866,667=0.2885~0.289 Calculate # of common shares outstanding, given conversion: 2000*200=400,000 shares of common. These would be considered outstanding at the beginning of the year, therefore the # of shares outstanding would be: (700+400)*2/12+(700+400+200)*10/12=1,266,666.67~1,266,667 shares Calculate the Diluted EPS, in the case of preferred conversion = NI/#shares outstanding=330,000/1,266,667=0.2605~0.261 So, is the answer B?

yes… thanks… i had doubt about the year… looks like its typo and data is for 2006…

What is the answer then? B right?

Answer is B.

Much easier step =330,000 divided by 700,000(2/12)+900000(8/12)+400,000 =$0.2605 ~ $0.261

Even though the preferred shares are issued in 2005, they are still outstanding in 2006 and hence needs to be considered in calculating diluted EPS.

jrbbikerx Wrote: ------------------------------------------------------- > Much easier step > > =330,000 > > divided by > > 700,000(2/12)+900000(8/12)+400,000 > > =$0.2605 ~ $0.261 Except it is 900,000*10/12 And as a general rule, you should always calculate the basic EPS, just to be sure of dilutive securities actually being dilutive. Cause if the potentially dilutive securities are not dilutive, the diluted EPS = basic EPS.

agree with map1, 100%. Just because they ask for diluted EPS – do not directly go to calculate the diluted EPS. make sure it is < Basic EPS, first – only then it is Dilutive.

i meant 10/12

What happens to the dividends paid? Why isn’t it deducted from the net income in the numerator?

Net income was $330,000. The tax rate was 40 percent. 700,000 shares of common stock were outstanding on January 1. The average market price per share was $6 in 2006. Dividends were paid in 2006. 2,000 shares of 8% $500 par value preferred shares, convertible into common shares at a rate of 200 common shares for each preferred share, were issued in 2005. 200,000 shares of common stock were issued on March 1. Gerrard, Inc.’s diluted earnings per share (diluted EPS) was closest to: A) $0.289. B) $0.261. C) $0.197. D) $0.254. Calculate WASO: 1/1 700 * 12/12 3/1 200 * 10/12 So WASO = 700 + 166.67 = 866.67 Basic EPS: ( 330 - 2 * 500 * .08 ) / 866.67 = .2884 Now only the preferred share is convertible. Once it is converted to common shares, there will no longer be any more Preferred dividend to pay. So numerator = 330 Denominator = 866.67 + 2 * 200 = 1266.67 So Diluted EPS = 330 / 1266.67 = .261