Question

INTERMEDIATE FINANCIAL ACCOUNTING II ANCHOR INC. EPS Anchor, Inc. had income after taxes of $500,000 for the current year. An average of 125,000 shares of Anchor's common stock was outstanding for the entire year, and 130,000 shares were outstanding at year-end. In addition, options were outstanding throughout the year to buy 12,000 shares of Anchor common stock at $7.50 per share. During the year, Anchor's common stock had an average market price of $9 per share. The stock was selling for $10 per share at year-end. Anchor is subject to a 34 percent tax rate and amortizes its bonds using a straight-line method. Anchor had the following convertible securities outstanding throughout the current year: 1. 6%, cumulative, convertible preferred stock. Each $10 par value share is convertible into 1.5 common shares. A total of $100,000 par value is outstanding. 2. 8 percent, 10-year, $1,000 par convertible bonds that were issued at 105. Total par value outstanding is $100,000. Each bond converts into 90 shares of common stock. 3. 13 percent, 5-year, $1,000 par convertible bonds that were issued at 97. Total par value outstanding is $30,000. Each bond converts into 30 shares of common stock. 4.7 percent, 8-year, $1,000 par convertible bonds that were issued at 95. Total par value outstanding is $60,000. Each bond converts into 20 shares of common stock. 5. An 11%, 20-year, $1,000 par convertible bonds that were issued at face value. The total par value outstanding is $500,000. Each bond converts into 20 shares of common stock. Required: Calculate Anchor Inc.'s basic and diluted EPS for the current year. Note: Use straight-line amortization for all the bonds. For example, if you have a 15 year, 10%, $1,000 face value bond issued at 85 and a $150 discount at issue, then $10 will be amortized each period using straight line amortization. You would have the following: At issue: 850 Cash Discount on B/P Bonds Payable 150 1,000 Periodic entries: 110 Interest Expense Discount on B/P Cash 10 100

Answer 1

Answer:

1) Calculation of Basic EPS

Basic EPS = (Net Income - Preferred Dividend) / weighted average number of shares outstanding

= ($5,00,000 - 6% x $1,00,000) / 1,25,000

= ($5,00,000 - $6,000) / 1,25,000

= $4,94,000/1,25,000

Basic EPS = $3.95 per Share

2) Calculation of Diluted EPS

If Incremental EPS < Basic EPS = Potentially Dilutive

If Incremental EPS > Basic EPS = Anti-dilutive

Calculation of Incremental EPS

a) Stock Options:

Income Effect = $0

Share Effect = N(1-X/S) x Fraction of Year   

where,

N = Shares Issued

S = Average Stock Price during Year

X = Exercise Price

Share Effect = 12000(1-$7.50/$9) x 1

= 2000

Incremental EPS = Income Effect / Share Effect

= $0/2000

Incremental EPS = $0 < Basic EPS = $3.95 Stock Optiions are Potentially Dilutive

b) Convertible Preffered Stock :

Income Effect = Preferred Dividends x Fraction of Year

= $6000 x 1

Income Effect = $6000

Share Effect = Shares Outstanding to be Issued x Fraction of Year

= ($1,00,000/$10) x 1.5 x 1

Share Effect = 15000 shares

Incremental EPS = $6000/15000

Incremental EPS = $0.40 < Basic EPS = $3.95 Convertible Preffered Stock are Potentially Dilutive

c) 8% Convertible Bonds :

Income Effect = (1-Tax Rate) x Interest Expense x Fraction of Year

= (1 - 34%) x 8% x $1,00,000 x 1

= $5280

Share Effect = Shares Outstanding to be Issued x Fraction of Year

= ($1,00,000/$1,000) x 90 x 1

= 9000 Shares

Incremental EPS = $5280/9000

Incremental EPS = $0.59  < Basic EPS = $3.95 8% Convertible Bonds are Potentially Dilutive

d) 13% Convertible Bonds :

Income Effect = (1-Tax Rate) x Interest Expense x Fraction of Year

= (1 - 34%) x 13% x $30,000 x 1

= $2574

Share Effect = Shares Outstanding to be Issued x Fraction of Year

= ($30,000/$1,000) x 30 x 1

= 900 Shares

Incremental EPS = $2574/900

Incremental EPS = $2.86 < Basic EPS = $3.95 13% Convertible Bonds are Potentially Dilutive

d) 7% Convertible Bonds :

Income Effect = (1-Tax Rate) x Interest Expense x Fraction of Year

= (1 - 34%) x 7% x $60,000 x 1

= $2772

Share Effect = Shares Outstanding to be Issued x Fraction of Year

= ($60,000/$1,000) x 20 x 1

= 1200 Shares

Incremental EPS = $2772/1200

Incremental EPS = $2.31 < Basic EPS = $3.95 7% Convertible Bonds are Potentially Dilutive

d) 11% Convertible Bonds :

Income Effect = (1-Tax Rate) x Interest Expense x Fraction of Year

= (1 - 34%) x 11% x $5,00,000 x 1

= $36300

Share Effect = Shares Outstanding to be Issued x Fraction of Year

= ($5,00,000/$1,000) x 20 x 1

= 10,000 Shares

Incremental EPS = $36300/10,000

Incremental EPS = $3.63 < Basic EPS = $3.95 11% Convertible Bonds are Potentially Dilutive

Rank: Give rank in ascending order on the basis incremental EPS.

1) Stock Options

2) Convertible Preffered Stock

3) 8% Convertible Bonds

4) 7% Convertible Bonds

5) 13% Convertible Bonds

6) 11% Convertible Bonds

Calculation of Diluted EPS

	Particular	Income Effect	Shhare Effect	Incremental EPS	Diluted EPS
	Basic Eps	494000	125000		3.95
Add:	Stock Options	0	2000	$0<$3.95	Dilutive
		494000	127000		3.89
Add:	Convertible Preffered Stock	6000	15000	$0.4<$3.89	Dilutive
		500000	142000		3.52
Add:	8% Convertible Bonds	5280	9000	$0.59<$3.52	Dilutive
		505280	151000		3.35
Add:	7% Convertible Bonds	2772	1200	$2.31<$3.35	Dilutive
		508052	152200		3.34
Add:	13% Convertible Bonds	2574	900	$2.86<$3.34	Dilutive
		510626	153100		3.34
Add:	8% Convertible Bonds	36300	10000	$3.63>$3.34	Anti Dilutive

So, Diluted EPS = $3.34