# During 2016, Choco has 450,000 shares of $1 par common stock and 20,000 shares of 6%,$10 par...

## Question:

During 2016, Choco has 450,000 shares of $1 par common stock and 20,000 shares of 6%,$10 par preferred stock outstanding. The preferred stock does not have cumulative or convertibility features.

Choco declared and paid cash dividends of $220,000 during 2016. 9/1/2016, 60,000 shares of common stock were reacquired as a treasury stock. Executive stock options granted in 2010, exercisable after 2015 for 100,000 common shares at an exercise price of$15 (the average market price of the common stock during 2016 was $20/share) On 1/1/2014, Choco issued$2,000,000 of convertible 5% bonds at a face value. Each $1,000 bond is convertible into 5 common shares in 2016. Net income for the year ended 12/31/2016 was$916,000.

The income tax rate is 40%.

Required:

Calculate basic EPS in 12/31/2016.

Calculate diluted EPS in 12/31/2016.

## Earning Per Share:

Earning per share is calculated to find out the amount of profit each common stock is generating from the operation. This ratio is calculated by dividing total income from operation with the number of shares outstanding.

Basic EPS can be evaluated as follows:

{eq}Basic\ EPS =\dfrac{ Earnings\ available\ to\ Equity\ Shareholders} { Number\ of\ Equity\ Shares} {/eq}

Earnings available to Equity Shareholders = Net income - Tax @ 40% - Preference Dividend

Earnings available to Equity Shareholders = $916,000 -$366,400 - ($200,000 * 6%) Earnings available to Equity Shareholders =$537,600.

{eq}Basic\ EPS = \dfrac{\$537,600} { 450,000\ shares} {/eq} Basic EPS =$1.195 per share.

Diluted EPS can be evaluated as follows:

Revised Number of Shares = Existing-acquired by repurchase + Options + Converted during the year

Options:

Shares in Option = 100,000

Market Price is $20, but the Exercise price is only$15.

Amount paid by Option holders = 100,000 * $15 Amount paid by Option holders =$1,500,000

{eq}Shares\ obtained\ in\ market\ for \ \$15,00,000 = \dfrac{\$1,500,000} { \$20}\\ Shares\ obtained\ in\ market\ for \ \$1,500,000 = 75,000\ shares. {/eq}

Difference is (100,000 - 75,000) = 25,000 shares will be added to Diluted shares

{eq}Shares\ through\ Convertible\ Bonds =\dfrac{\$2,000,000}{1,000} \ \times \ 5 \\ Shares\ through\ Convertible\ Bonds \ = \ 100,000 \ shares {/eq} Number of shares = 450,000 - 60,000 + 75,000 + 100,000 Number of shares = 565,000 shares Revised Income =$916,000 + Interest savings on Bonds

Revised Income = $916,000 + ($2,000,000 * 5%)

Revised Income = $1,016,000 Diluted EPS =$1,016,000 - Tax @ 40% - Preference Dividend / Number of Shares

Diluted EPS = {eq}\dfrac{\$597,600}{565,000 \ shares } {/eq} Diluted EPS =$1.057 per share

Dilution in Earnings = Basic EPS - Diluted EPS

Dilution in Earnings = 1.195 - 1.057

Dilution in Earnings = \$0.138 per share 