Question

Problem 19-13 EPS; nonconvertible preferred stock; treasury shares; shares sold; stock dividend; options, convertible bonds; contingently issuable shares [LO19-4, 19-5, 19-6, 19-7, 19-8, 19-9, 19-10, 19-11] On December 31, 2015, Dow Steel Corporation had 770,000 shares of common stock and 47,000 shares of 9%, noncumulative, nonconvertible preferred stock issued and outstanding. Dow issued a 5% common stock dividend on May 15 and paid cash dividends of $570,000 and $86,000 to common and preferred shareholders, respectively, on December 15, 2016. On February 28, 2016, Dow sold 68,000 common shares. Also, as a part of a 2015 agreement for the acquisition of Merrill Cable Company, another 35,000 shares (already adjusted for the stock dividend) are to be issued to former Merrill shareholders on December 31, 2017. if Merrill's areholders on December 31, 2017, if Merrill's 2017 net income is at least $670,000. In 2016, Merrill's net income was $800,000 In keeping with its long-term share repurchase plan, 4,000 shares were retired on July 1. Dow's net income for the year ended December 31, 2016, was $2,950,000. The income tax rate is 40%. As part of an incentive compensation plan, Dow granted incentive stock options to division managers at December 31 of the current and each of the previous two years. Each option permits its holder to buy one share of common stock at an exercise price equal to market value at the date of grant and can be exercised one year from that date. Information concerning the number of options granted and common share prices follows: Date Granted Share Price December 31, 2014 December 31, 2015 December 31, 2016 Options Granted (adjusted for the stock dividend) 24,000 19,000 22,500 $40 $49 $48 The market price of the common stock averaged $48 per share during 2016. On July 12, 2014, Dow issued $900,000 of convertible 10% bonds at face value. Each $1,000 bond is convertible into 40 common shares (adjusted for the stock dividend) Required: Compute Dow's basic and diluted earnings per share for the year ended December 31, 2016. (Enter your answers in thousands.) Answer is complete but not entirely correct. Numerator Denominator = Dow's S 866 = Earnings per share $ 3.31 $ 2.97 2,8641 2,918 basic Dow's diluted 981 =

Answer 1

DOW STEEL CORPORATION

Numerator ( Basic EPS)

Net Income = $ 2,950,000

Preferred Dividends = $ 86,000 ( because the preferred stock is noncumulative only include the dividends that are actually paid)

Denominator ( Basic EPS) : Weighted average # share of common stock

​​​​​​​outstanding.

1/1/ - 12/31 : 770,000 * 12/12 = 770,000 *1.05 = 808,500

2/28 - 12/31 : 68,000 * 10/12 = 56,666.66 * 1.05 = 59,500

7/1 - 12/31 : (4,000) * (6/12) = (2,000)

Weighted Average Shares; = 866,000

​​​​​Basic EPS = ($2,950,000 - $86,000) ÷ 866,000 = 3.31

Stock Option : Use the Treasury Stock Method if dilutive.

24,000 option issued 12/31/14 with exercise price $ 40

1. Are they dilutive ? Yes because the excercise price of $ 40 less than market price of $48 . Assume excercise at the later of the date of issue ( 12/31/2013) or the beginning of the year 1/1/15.

2. Proceeds received upon excercise ( $ 40 * 24,000) = $960,000

3.Share repurchased at current market price = $20,000 ($ 960,000 % 48)

4. Net Increase in share = 4,000 (24,000 - 20,000)

19000 option issued 12/31/15 with excercise price $49

1.Are they dilutive ? No because the excercise price $ 49 is not less than the market price $ 48 , Therefore, ignore .

2. 22,500 option issued 31/12/16 with excercise price of $ 48 .

1. Are they dilutive ? No because the excercise price of $48 is not less than the market price of $ 48 . Therefore ignore.

Basic EPS = ($ 2,950,000 - $ 86,000) / $866,000 = 3.31

​​​​​​​Diluted ESP = ($ 2,950,000 - $ 86,000) / ($866,000 + 4,000) = 3.29

	Numerator	Denominator	Earning Per Share
Dows Basic	$2,864	$ 866	3.31
Dows Diluted	$2,864	$ 870	3.29