1. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Chapter 20 Earnings Per Share

2. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-2 Earnings Per Share (EPS) Of the myriad of facts and figures generated by accountants, the single accounting number that is reported most frequently in the media and receives by far the most attention by investors and creditors is earnings per share.

3. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-3 Number of shares outstanding × Number of months outstanding ÷ 12 Weighted average shares outstanding Simple Capital Structure (Basic EPS) Basic Earnings Per Share Net income (after tax) – Preferred dividends* Weighted average outstanding common stock Net income (after tax) – Preferred dividends* Weighted average outstanding common stock period’s cumulative preferred stock dividends (whether or not declared) and noncumulative preferred stock dividends (only if declared). *Current period’s cumulative preferred stock dividends (whether or not declared) and noncumulative preferred stock dividends (only if declared).

4. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-4 Earnings Per Share A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. EPS would be A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. EPS would be a. $7.50 a. $7.50 b. $7.43 b. $7.43 c. $7.45 c. $7.45 d. $7.38 d. $7.38 A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. EPS would be A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. EPS would be a. $7.50 a. $7.50 b. $7.43 b. $7.43 c. $7.45 c. $7.45 d. $7.38 d. $7.38

5. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-5 A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. EPS would be A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. EPS would be a. $7.50 a. $7.50 b. $7.43 b. $7.43 c. $7.45 c. $7.45 d. $7.38 d. $7.38 A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. EPS would be A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. EPS would be a. $7.50 a. $7.50 b. $7.43 b. $7.43 c. $7.45 c. $7.45 d. $7.38 d. $7.38 Earnings Per Share $1,500,000 – (10,000 × 5% × $20 par) 200,000 shares Since dividends were not declared, only the cumulative preferred stock dividends are subtracted. $1,500,000 – (10,000 × 5% × $20 par) 200,000 shares Since dividends were not declared, only the cumulative preferred stock dividends are subtracted.

6. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-6 Issuance of New Shares Compute the weighted average number of shares of common stock outstanding. Compute the weighted average number of shares of common stock outstanding.

7. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-7 Issuance of New Shares Compute the weighted average number of shares of common stock outstanding. Compute the weighted average number of shares of common stock outstanding.

8. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-8 Stock Dividends and Stock Splits Common shares issued as part of stock dividends and stock splits are treated retroactively as subdivisions of the shares already outstanding at the date of the split or dividend.

9. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-9 Stock Dividends and Stock Splits Compute the weighted average number of shares of common stock outstanding. Compute the weighted average number of shares of common stock outstanding.

10. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-10 Stock Dividends and Stock Splits Compute the weighted average number of shares of common stock outstanding. Compute the weighted average number of shares of common stock outstanding.

11. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-11 Stock Dividends and Stock Splits Retroactive treatment: Stock dividend or split is treated as outstanding from the beginning of the period. Stock dividend or split is applied retroactively in proportion to the number of shares outstanding at the time of the dividend or split. New shares issued this period? New shares issued this period? Yes No

12. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-12 Reacquired Shares The weighted average number of shares is reduced by the number of reacquired shares, time-weighted for the fraction of the year they were not outstanding.

13. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-13 Reacquired Shares Compute the weighted average number of shares of common stock outstanding. Compute the weighted average number of shares of common stock outstanding.

14. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-14 Reacquired Shares Compute the weighted average number of shares of common stock outstanding. Compute the weighted average number of shares of common stock outstanding.

15. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-15 Complex Capital Structure (dual EPS) Dilution/Antidilution Test Equity contracts Convertible securities Treasury stock method If-converted method Contingently issuable shares Potentially dilutive securities: Stock options, rights, and warrantsStock options, rights, and warrants Convertible bonds and stockConvertible bonds and stock Contingent common stock issuesContingent common stock issues Potentially dilutive securities: Stock options, rights, and warrantsStock options, rights, and warrants Convertible bonds and stockConvertible bonds and stock Contingent common stock issuesContingent common stock issues Diluted Earnings Per share

16. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-16 Complex Capital Structure Dual presentation of Earnings Per Share: Basic EPS Diluted EPS

17. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-17 Options, Rights, and Warrants Proceeds Used to Purchase treasury shares At average market price The treasury stock method assumes that proceeds from the exercise of equity contracts are used to purchase treasury shares. This method usually results in a net increase in shares included in the denominator of the calculation of diluted earnings per share.

18. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-18 Options, Rights, and Warrants Proceeds from assumed exercise Average market price of stock Proceeds from assumed exercise Average market price of stock  Determine new shares from assumed exercise of equity contract.  Compute shares purchased for the treasury.

19. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-19 Options, Rights, and Warrants  Determine new shares from assumed exercise of equity contract.  Compute shares purchased for the treasury.  Compute the incremental shares assumed outstanding. New shares from assumed exercise (1) Less: Treasury shares assumed purchased (2) Net increase in shares outstanding (3)

20. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-20 Options, Rights, and Warrants When the exercise price exceeds the market price, the options are antidilutive.

21. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-21 Treasury Stock Method Common stock outstanding was 100,000 shares. Options to purchase 5,000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at $50 per share. The average market price of the stock was $80. The net increase in the dilutive earnings per share denominator is Common stock outstanding was 100,000 shares. Options to purchase 5,000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at $50 per share. The average market price of the stock was $80. The net increase in the dilutive earnings per share denominator is a. 25,000 shares b. 5,000 shares c. 3,125 shares d. 1,875 shares Common stock outstanding was 100,000 shares. Options to purchase 5,000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at $50 per share. The average market price of the stock was $80. The net increase in the dilutive earnings per share denominator is Common stock outstanding was 100,000 shares. Options to purchase 5,000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at $50 per share. The average market price of the stock was $80. The net increase in the dilutive earnings per share denominator is a. 25,000 shares b. 5,000 shares c. 3,125 shares d. 1,875 shares

22. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-22 Common stock outstanding was 100,000 shares. Options to purchase 5,000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at $50 per share. The average market price of the stock was $80. The net increase in the dilutive earnings per share denominator is Common stock outstanding was 100,000 shares. Options to purchase 5,000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at $50 per share. The average market price of the stock was $80. The net increase in the dilutive earnings per share denominator is a. 25,000 shares b. 5,000 shares c. 3,125 shares d. 1,875 shares Common stock outstanding was 100,000 shares. Options to purchase 5,000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at $50 per share. The average market price of the stock was $80. The net increase in the dilutive earnings per share denominator is Common stock outstanding was 100,000 shares. Options to purchase 5,000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at $50 per share. The average market price of the stock was $80. The net increase in the dilutive earnings per share denominator is a. 25,000 shares b. 5,000 shares c. 3,125 shares d. 1,875 shares Treasury Stock Method New shares = 5,000 Treasury shares = 3,125 (5,000 × $50) ÷ $80 Incremental shares = 1,875 (5,000 - 3,125) (5,000 - 3,125) New shares = 5,000 Treasury shares = 3,125 (5,000 × $50) ÷ $80 Incremental shares = 1,875 (5,000 - 3,125) (5,000 - 3,125)

23. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-23 Next: Convertible Securities

24. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-24 Convertible Securities The if-converted method is used for Convertible debt and equity securities The if-converted method is used for Convertible debt and equity securities The method assumes conversion occurs as of the beginning of the period or date of issuance, if later.

25. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-25 Convertible Securities The assumed conversion of convertible bonds or preferred stock has two effects on dilutive earnings per share: The assumed conversion of convertible bonds or preferred stock has two effects on dilutive earnings per share:  Increases the denominator by the number of common shares issuable upon conversion.  Increases the numerator by decreasing after-tax interest expense on convertible bonds, and dividends on convertible preferred stock.

26. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-26 Convertible Securities Dilutive earnings per share may decrease or increase after the assumed conversion. If dilutive earnings per share decreases, the securities are dilutive and are assumed converted. If dilutive earnings per share increases, the securities are antidilutive and are not considered converted.

27. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-27 If-Converted Method Assume net income (after tax) of $500,000, cumulative convertible preferred stock dividends of $25,000, common stock outstanding of 50,000 shares, and a tax rate of 30%. The convertible preferred stock is convertible into 5,000 shares of common stock. Is the convertible preferred stock dilutive? Is the convertible preferred stock dilutive? Assume net income (after tax) of $500,000, cumulative convertible preferred stock dividends of $25,000, common stock outstanding of 50,000 shares, and a tax rate of 30%. The convertible preferred stock is convertible into 5,000 shares of common stock. Is the convertible preferred stock dilutive? Is the convertible preferred stock dilutive?

28. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-28 If-Converted Method = $9.50 EPS EPS without conversion: $500,000 – $25,000 50,000 shares 50,000 shares If the preferred stock is converted, we would not have dividends and the number of shares of common stock would increase by 5,000 shares. There is not a tax effect. = $9.09 EPS Dilutive.Dilutive. EPS after assumed conversion: $500,000 – $0 55,000 shares

29. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-29 If-Converted Method Assume net income (after tax) of $500,000, convertible bonds with interest expense of $50,000, common stock outstanding of 50,000 shares, and a tax rate of 30%. The bonds are convertible into 2,000 shares of common stock. Assume net income (after tax) of $500,000, convertible bonds with interest expense of $50,000, common stock outstanding of 50,000 shares, and a tax rate of 30%. The bonds are convertible into 2,000 shares of common stock. Are the convertible bonds dilutive? Assume net income (after tax) of $500,000, convertible bonds with interest expense of $50,000, common stock outstanding of 50,000 shares, and a tax rate of 30%. The bonds are convertible into 2,000 shares of common stock. Assume net income (after tax) of $500,000, convertible bonds with interest expense of $50,000, common stock outstanding of 50,000 shares, and a tax rate of 30%. The bonds are convertible into 2,000 shares of common stock. Are the convertible bonds dilutive?

30. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-30 If-Converted Method = $10.00 EPS EPS without conversion: $500,000 $500,000 50,000 shares If the bonds are converted, net income would increase by $35,000 (after taxes) and the number of shares of common stock would increase by 2,000 shares. = $10.29 EPS No, they are antidilutive. EPS after assumed conversion: $535,000 52,000 shares

31. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-31 Order of Entry for Multiple Convertible Securities When a company has more than one potentially dilutive security, they are considered for inclusion in dilutive EPS in sequence from the most dilutive to the least dilutive.

32. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-32 Contingently Issuable Shares Contingent shares are issuable in the future for little or no cash consideration upon the satisfaction of certain conditions. Future

33. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-33 Contingently Issuable Shares Shares are issued merely due to passage of time. Some target performance level has already been met and is expected to continue to the end of the contingency period. Contingent shares are included in dilutive EPS if: Example: Additional shares may be issued based on future earnings.

34. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-34 Contingently Issuable Shares Contingent shares are considered outstanding common shares and are included in basic EPS as of the date that all necessary conditions have been satisfied.

35. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-35 Summary

36. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-36 Summary

37. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-37 Financial Statement Presentation of EPS Data  Income from continuing operations.  Discontinued operations.  Extraordinary items.  Cumulative effect of change in accounting principle.  Net income. Earnings per share values are desirable (but not required) for extraordinary items and discontinued operations.  Income from continuing operations.  Discontinued operations.  Extraordinary items.  Cumulative effect of change in accounting principle.  Net income. Earnings per share values are desirable (but not required) for extraordinary items and discontinued operations.

38. © 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 20-38 End of Chapter 20