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Earnings per Share

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Earnings per Share The Introductory Lecture for Acct 592 The most closely watched statistic on Wall Street Earnings per share (EPS) is an important indicator of the ... – PowerPoint PPT presentation

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Title: Earnings per Share


1
Earnings per Share
  • The Introductory Lecturefor Acct 592

2
The most closely watched statistic on Wall Street
  • Earnings per share (EPS) is an important
    indicator of the success or failure of a company.

3
Several components of EPS must be disclosed if
there are discontinued operations, extraordinary
items, or cumulative effects of changes in
accounting principles.
  • Earnings Per Share
  • Continuing operations
    3.15
  • Discontinued operations
    .67
  • Extraordinary loss
    (.15)
  • Cumulative effect of accounting change .17
  • Net Earnings Per Share
    3.84

Cumulative effect item pretty much gone after
SFAS No. 154
4
There may be two EPS numbers for each item
Diluted
Basic
Reflects the maximum potential dilution from all
possible stock conversions that would have
decreased EPS.
Considers only common shares outstanding
5
Diluted earnings per share
  • I like to think of it as the worst case
    scenario
  • It is the lowest possible number wed report for
    EPS
  • It is a proforma number, not a fact

6
Capital structure determines reporting
  • Many companies will report basic earnings per
    share only
  • Other companies must report BOTH basic and
    diluted earnings per share
  • It depends on whether the capital structure is
  • Simple, or
  • Complex

7
A simple capital structure consists of only
common stock.
The corporation has only common and
nonconvertible preferred stock and has no
convertible securities, stock options, warrants,
or other rights outstanding.
8
Capital Structures
Complex Capital Structure The corporation has
one or more instruments outstanding that could
result in issuance of additional common shares.
9
Capital Structures
Therefore, a company with potential per share
dilution is considered to have a complex capital
structure.
Note that a potentially dilutive security does
not necessarily dilute EPS
10
Dilution of Earnings
  • Dilutive Securities Securities whose assumed
    exercise or conversion results in a reduction in
    earnings per share.
  • Antidilutive Securities Securities whose
    assumed conversion or exercise results in an
    increase in earnings per share.

11
Basic Earnings Per Share
Net Income - Preferred Dividends Weighted
average number of common shares outstanding
12
Earnings Per Share Example
  • A company has the following capital structure at
    the end of 2002
  • 6 Cumulative preferred stock, 100 par value,
    issued and outstanding 10,000 shares
  • Common stock, 10 par, issued 200,000 shares,
    outstanding 180,000 shares
  • Treasury stock (20,000 shares at cost of 18)
  • Page 109

13
EPS Example
  • During 2003, the following transactions take
    place
  • April 1, 2003 issued 100,000 shares to acquire
    the assets of another company. Market value of
    shares was 25
  • June 30, 2003 declared and distributed a 2 for
    1 stock split effected in the form of a stock
    dividend
  • September 1, 2003 sold 10,000 shares of the
    treasury stock for 28 per share

Page 109
14
Step 1 find weighted average shares outstanding
15
Step 1 find weighted average shares outstanding
16
EPS Example
  • During 2003, the following transactions take
    place
  • April 1, 2003 issued 100,000 shares to acquire
    the assets of another company. Market value of
    shares was 25
  • June 30, 2003 declared and distributed a 2 for
    1 stock split effected in the form of a stock
    dividend
  • September 1, 2003 sold 10,000 shares of the
    treasury stock for 28 per share

Page 109
17
Stock Splits Dividends
  • All stock splits and stock dividends must be
    incorporated into the computation of weighted
    average shares outstanding.
  • This must done for all periods presented in the
    financial statements.

18
Step 1 find weighted average shares outstanding
19
Stock Splits Dividends
  • This years EPS figures may have to be changed in
    the future as a result of stock splits or
    dividends.
  • Think about what would happen if we did NOT make
    the adjustment . . .

20
EPS Example
  • During 2003, the following transactions take
    place
  • April 1, 2003 issued 100,000 shares to acquire
    the assets of another company. Market value of
    shares was 25
  • June 30, 2003 declared and distributed a 2 for
    1 stock split effected in the form of a stock
    dividend
  • September 1, 2003 sold 10,000 shares of the
    treasury stock for 28 per share

Page 109
21
Step 1 find weighted average shares outstanding
22
Step 1 find weighted average shares outstanding
Multiply shares outstanding by fraction of year
and by split factor
Add em up
Make sure you have accounted for all 12 months
and no more than 12 months!
23
Step 2 - numerator
  • Net income 3,000,000
  • Preferred dividends 10,000 shares 100
    6 60,000

Note Always include preferred dividend if it is
cumulative preferred stock. If not cumulative,
only include preferred dividend if declared
during year
Now lets plug everything into the formula . . .
24
Step 3 compute basic EPS
25
What if . . .
  • Taking the same facts, what if the preferred
    stock was convertible into 10 shares of common
    stock at the option of the stockholder?
  • This would make it a complex capital structure
    and wed have to report both the basic EPS we
    computed plus a diluted earnings per share
    figure.

Page 111
26
Convertible preferred
  • The 10,000 shares of preferred could become
    100,000 shares of common stock (outstanding all
    year)
  • We would NOT pay the preferred dividend because
    there would be no preferred stock

27
Diluted EPS
  • Diluted EPS 4.89
  • Both the 5.73 and the 4.89 would be reported on
    the face of the income statement

28
Formula for diluted EPS
Net income - Preferred dividends if preferred stock is NOT convertible After-tax bond interest on conver-tible bonds
Weighted average of common shares assuming maximum dilution (including options) Weighted average of common shares assuming maximum dilution (including options) Weighted average of common shares assuming maximum dilution (including options)
29
Diluted Earnings per Share
  • For convertible bonds and convertible preferred
    stock we use what is called the If Converted
    Method
  • For options, we use the Treasury Stock Method

30
Treasury Stock Method
  • Proceeds from conversion are assumed to be used
    for purchase of treasury stock at current market
    price.
  • Treasury stock is assumed to be reissued to
    option or warrant holders.
  • Any additional shares issued, over treasury
    stock, are added to weighted- average shares
    outstanding.
  • Exercise is assumed to occur on the first day of
    the year unless issue date is later.

31
Treasury Stock Method--Example Basic Data
  • Assume the following
  • Net Income 8,000
  • Common Shares Outstanding (entire year)
    6,000
  • 1-for-1 Options Outstanding 2,000
  • Exercise Price Per Share on Options 30
  • Average Price of Common Shares 40
  • Income Tax Rate 40

32
Treasury Stock Method--Example
33
Treasury Stock Method--Example Option Proceeds
  • Options Assumed Exercised (2,00030) 60,000
    cash received
  • Shares Assumed Repurchased With Proceeds
    (60,000 / 40) 1,500
  • Additional Shares Assumed Issued2,000 from
    exercise less 1,500 purchased with proceeds 500
    net new shares

34
Treasury Stock Method--Example

8,000/6,500
35
Getting the lowest possible number an algorithm
  • 1. Compute the per share effect of each
    potentially dilutive security separately.
  • 2. Make a list from smallest per share number to
    largest per share number
  • 3. Compute basic earnings per share
  • 4. For diluted EPS, take the securities into EPS
    computation one at a time until the next item on
    the list is bigger than the most recent EPS
    figure.
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