Question

On December 31, 2017, Dow Steel Corporation had 640,000 shares of common stock and 34,000 shares of 8%, noncumulative, nonconvertible preferred stock issued and outstanding. Dow issued a 4% common stock dividend on May 15 and paid cash dividends of $440,000 and $73,000 to common and preferred shareholders, respectively, on December 15, 2018. On February 28, 2018, Dow sold 57,000 common shares. Also, as a part of a 2017 agreement for the acquisition of Merrill Cable Company, another 27,000 shares (already adjusted for the stock dividend) are to be issued to former Merrill shareholders on December 31, 2019, if Merrill's 2019 net income is at least $540,000. In 2018, Merrill's net income was $670,000. In keeping with its long-term share repurchase plan, 6,000 shares were retired on July 1. Dow's net income for the year ended December 31, 2018, was $2,300,000. 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 Options Granted Share Price (adjusted for the stock dividend) December 31, 2016 11,000 $ 14 December 31, 2017 6,000 $ 23 December 31, 2018 9,500 $ 22 The market price of the common stock averaged $22 per share during 2018. On July 12, 2016, Dow issued $800,000 of convertible 10% bonds at face value. Each $1,000 bond is convertible into 35 common shares (adjusted for the stock dividend). Required: Compute Dow's basic and diluted earnings per share for the year ended December 31, 2018. (Enter your answers in thousands.)

Answer 1

Basic Earnings Per Share for the year ended December 31, 2018 = Earnings available to Common Shareholders/Basic Number of Outstanding Shares

Earnings available to Common Shareholders = Net Income - Preferred Dividends

= $2,300,000 - $73,000

= $2,227,000

Basic Number of Outstanding Shares = Outstanding Shares + New Issue of Shares - Repurchase of Shares

= 640,000 + 57,000 - 6,000

= 691,000 shares

Therefore, basic earnings per share = $2,227,000/691,000 shares

= $3.22 per share

Diluted Earnings per share for the year ended December 31, 2018 = Earnings available to Common Shareholders/Diluted number of shares

Diluted number of shares = Basic Number of Outstanding Shares + Options Granted on Dec. 31, 2018

= 691,000 shares + 9,500 shares

= 700,500

Therefore, Diluted Earnings per share = $2,227,000/700,500 shares

= $3.18 per share.

Note: The convertible bonds are not yet converted into common shares as per the wordings in the question, hence, they are not considered.