PROBLEM 16-5

The computation of Fitzgerald Pharmaceutical Industries’ basic

earnings per share and the diluted earnings per share for the fiscal
year ended June 30, 2014, are shown below.

Net income – Preferred dividends

(a) Basic earnings per share = Weighted-average number of shares
outstanding

$1,500,000 – $75,0001
=
1,000,000

$1,425,000
=
1,000,000

= $1.425 or $1.43 per share

1
Preferred dividend = .06 X $1,250,000
= $75,000

Net income – Preferred dividends +

Interest (net of tax)
(b) Diluted earnings per share = Weighted-average number of shares
outstanding + Potentially dilutive
common shares

$1,500,000 – $75,000 + $240,0002

=
1,000,000 + 250,0003 + 50,0004

$1,665,000
=
1,300,000

= $1.2808 or $1.28 per share

2
Use “if converted” method for 8% bonds
Adjustment for interest expense (net of tax)
 ($5,000,000 X .08 X .6).............................................. $240,000

PROBLEM 16-5 (Continued)

3
Shares assumed to be issued if converted
$5,000,000 ÷ $1,000/bond X 50 shares......................... 250,000
4
Use treasury stock method to determine incremental
shares outstanding
Proceeds from exercise of options
(200,000 X $15)............................................................
$3,000,000

Shares issued upon exercise of options..................... 200,000

Shares purchasable with proceeds
(Proceeds ÷ Average market price)
($3,000,000 ÷ $20)......................................................
(150,000)
Incremental shares outstanding...........................
50,000
 PROBLEM 16-6

(a) Melton Corporation has a simple capital structure since it does

not have any potentially dilutive securities.

(b) The weighted-average number of shares outstanding that Melton

Corporation would use in calculating earnings per share for the
fiscal years ended May 31, 2014, and May 31, 2015, is 1,600,000
and 2,200,000 respectively, calculated as follows:

Dates Shares Fractio Weighte

Event Outstandin Outstandi Restateme n d
g ng nt of Year Shares
Beginning June 1–Oct. 1,000,000 1.20 4/12 400,000
balance 1
New Issue Oct. 1–May 1,500,000 1.20 8/12 1,200,00
31 0
1,600,00
0

Dates Shares Fractio Weighte

Event Outstanding Outstandi Restateme n d
ng nt of Year Shares
Beginning June 1–Dec. 1,800,000 6/12 900,000
balance 1
New Issue Dec. 1–May 2,600,000 6/12 1,300,00
31 0
2,200,00
0

(c) MELTON CORPORATION

Comparative Income Statement
For Fiscal Years Ended May 31, 2014 and 2015

      2014            2015     
Income from operations...........................................$1,800,000 $2,500,000
Interest expense1....................................................... 240,000 240,000
Income before taxes................................................. 1,560,000 2,260,000
Income taxes at 40%................................................. 624,000 904,000
Income before extraordinary item........................... 936,000 1,356,000
Extraordinary loss, net of income
 taxes of $240,000...................................................         —       (360,000)
Net income................................................................. $ 936,000 $ 996,000

Earnings per share:

Income before extraordinary loss.................... $0.552 $0.593
Extraordinary loss.............................................           0.164
Net income......................................................... $0.55 $0.435
PROBLEM 16-6 (Continued)
1
Interest expense = $2,400,000 X .10
= $240,000

2 (Net income – Preferred dividends)

Earnings per share =
Weighted-Average Number of Common Shares

($936,000 – $60,000*)
=
1,600,000

= $0.55 per share

*Preferred dividends = (No. of Shares X Par Value X Dividend %)
= (20,000 X $50 X .06)
= $60,000 per year

3 ($1,356,000 – $60,000)
Earnings per share =
2,200,000

= $0.59 per share

4 Extraordinary Item
Earnings per share =
Weighted-Average Number of Shares Outstanding

$360,000
=
2,200,000

= $0.16 per share

5 Net Income – Preferred Dividends

Earnings per share =
Weighted-Average Number of Shares Outstanding

$996,000 – $60,000
=
2,200,000

= $0.43
 PROBLEM 16-7

(a)The number of shares used to compute basic earnings per share is

4,951,000, as calculated below.

Dates Shares Fracti Weight

Event Outstandin Outstandi Restatem on ed
g ng ent of Shares
Year
Beginning
Balance,
including 5% Jan. 1–Apr. 2,100,000 2.0 3/12 1,050,0
stock dividend 1 00
Conversion of
preferred stock Apr. 1–July 2,520,000 2.0 3/12 1,260,0
1 00
Stock split July 1– 5,040,000 1/12 420,00
Aug. 1 0
Issued shares
for Aug. 1– 5,340,000 3/12 1,335,0
building Nov. 1 00
Purchase of
Treasury Nov. 1– 5,316,000 2/12 886,0
stock Dec. 31 00
Total number of common shares to compute basic earnings 4,951,0
per share 00

(b) The number of shares used to compute diluted earnings per

share is 5,791,000, as shown below.

Number of shares to compute

basic earnings per share..................................
4,951,000
Convertible preferred stock—
still outstanding (300,000 X 2 X 1.05) .............
630,000
Convertible preferred stock—
converted (400,000 X 2 X 1.05 X 3/12).............
210,000
Number of shares to compute diluted
earnings per share............................................
5,791,000
(c) The adjusted net income to be used as the numerator in the basic
earnings per share calculation for the year ended December 31,
2015, is $10,350,000, as computed below.

After-tax net income............................................ $11,550,000

Preferred stock dividends
March 31 (700,000 X $.75)............................ $525,000
June 30, September 30, and December 31
(300,000 X $.75 X 3)................................... 675,000
(1,200,000)
Adjusted net income $10,350,000
 PROBLEM 16-8

$1,200,000 – ($4,000,000 X .06)

(a) Basic EPS =
600,000*

= $1.60 per share

*$6,000,000 ÷ $10

(Net income – Preferred dividends) + Interest

savings (net of tax)
(b) Diluted EPS =
Weighted-average number of shares outstanding +
Potentially dilutive common shares

$1,200,000 – $240,000a + $84,000b

=
600,000 + 15,000c + 60,000d

$1,044,000
=
675,000

= $1.54 per share

a
Preferred stock is not included since conversion would be
antidilutive. That is, conversion of the preferred stock increases
the numerator $240,000 ($4,000,000 X .06) and the denominator
120,000 shares [(4,000,000 ÷ 100) X 3] as shown in the following:

Diluted EPS $1,200,000 + $84,000

=
with preferred. 600,000 + 15,000 + 60,000 + 120,000

$1,284,000
=
795,000

= $1.61 per share > $1.54; therefore

antidilutive.
b
$2,000,000 X .07 X (1 – .40)
PROBLEM 16-8 (Continued)

c
Market price – Option price
X Number of options = incremental shares
Market price

$25 – $20
X 75,000 = 15,000
$25
d
($2,000,000 ÷ $1,000) X 30 shares/bond

Note to instructor: This problem can be used to apply the procedures

in Appendix 17B for analysis of multiple dilutive securities.

First, compute the dilutive effect for each security and rank from
smallest to largest:

Options: $0/15,000 = $0
Convertible bonds: $84,000/60,000 = $1.40
Preferred: $240,000/120,000 = $2
EPS with options:

$1,200,000 – $240,000
=
600,000 + 15,000

= $1.56

This is less than basic EPS; continue to bonds: $1.54 (see (b) above)
which is less than diluted EPS with the options, so include. As
indicated above, the preferred is anti-dilutive, so we stop.
 PROBLEM 16-9

(a) Weighted-Average Shares

Before Stock After Stock
   Dividend     Dividend   
Total as of June 1, 2013 1,000,000 1,200,000
Issue of September 1, 2013 400,000    480,000
Total as of May 31, 2015 1,400,000 1,680,000

1. 1,200,000 X 3/12 = 300,000

1,680,000 X 9/12 = 1,260,000
Total 1,560,000

2. 1,680,000 X 12/12 1,680,000

(b) AGASSI CORPORATION

Comparative Income Statement
For the Years Ended May 31, 2015 and 2014

      2015           2014     

Income from operations before income taxes..... $1,400,000 $660,000
Income taxes.......................................................... 560,000 264,000
Income before extraordinary item........................ 840,000 396,000
Extraordinary item—loss from earthquake,
 less applicable income taxes of $160,000........ 240,000                
Net income.............................................................. $ 600,000 $396,000

Per share of common stock

Income before extraordinary item..................... $0.351 $0.103
Extraordinary loss, net of tax............................. (0.14)4   –     

Net income.............................................................. $0.212 $0.10

PROBLEM 16-9 (Continued)

Net income – Preferred dividends

EPS calculations =
Weighted-average common shares

Preferred dividends = 40,000 X $100 X .06 = $240,000

Extraordinary loss Loss

=
per share calculation Weighted-average common shares

1
($840,000 – $240,000) ÷ 1,680,000 = $0.35
2
($600,000 – $240,000) ÷ 1,680,000 = $0.21
3
($396,000 – $240,000) ÷ 1,560,000 = $0.10
4
$240,000 ÷ 1,680,000 = $0.14

(c) 1. A corporation’s capital structure is regarded as simple if it

consists only of common stock or includes no potentially
dilutive securities. Agassi Corporation has a simple capital
structure because it has not issued any convertible
securities, warrants, or stock options, and there are no
existing rights or securities that are potentially dilutive of its
earnings per common share.

2. A corporation having a complex capital structure would be

required to make a dual presentation of earnings per share;
i.e., both basic earnings per share and diluted earnings per
share. This assumes that the potentially dilutive securities
are not antidilutive.

The basic earnings per share computation uses only the

weighted-average of the common stock outstanding. The
diluted earnings per share computation assumes the
conversion or exercise of all potentially dilutive securities that
are not antidilutive.