At January 1, 2016, Canaday Corporation had outstanding the following securities

Question

At January 1, 2016, Canaday Corporation had outstanding the following securities: 790 million common shares 45 million 4% cumulative preferred shares, $50 par 6% convertible bonds, $3,000 million face amount, convertible into 80 million common shares The following additional information is available: • On September 1, 2016, Canaday sold 78 million additional shares of common stock. • Incentive stock options to purchase 50 million shares of common stock after July 1, 2015, at $10 per share were outstanding at the beginning and end of 2016. The average market price of Canaday’s common stock was $25 per share during 2016. • Canaday's net income for the year ended December 31, 2016, was $1,552 million. The effective income tax rate was 40%.

Explanation / Answer

Calculate the basic and diluted EPS for the year ended December 31, 2016.

Numerator (Basic EPS):

Net income = $1,552million;

Preferred dividends = $90 million [(4% x $50) x 45 million].

Because the preferred stock is cumulative dividends are included whether or not preferred stock is cumulative, dividends are included whether or not paid.

Denominator (Basic EPS): Weighted average # shares common stock outstanding

1/1 – 12/31 790 million x (12/12) = 790

9/1 – 12/31 78 million x (4/12) =       26

Weighted average # shares                816

Basic EPS = ($1,552- $90) ÷ 816 = $1.30

Stock Options: Use the Treasury Stock Method if dilutive.

1. Are the stock options dilutive? Yes because the exercise price of $10 is less than the average market price of $25.

2. Assume exercise at the later of the date of issue (7/1/15) or the beginning of the period (1/1/16). Assume exercise 1/1/16.

3. Proceeds received on exercise = 50 million x $10 = $500 million

4. # Shares repurchased = $500 million ÷ $25 = 20 million

5. Net increase in # shares outstanding = 30 million (50 million – 20 million)

6. EPS with the inclusion of the options:

($1,552- $90) ÷ (816 + 30) = $1.72

(this will be used to test for dilutive effect of convertible bonds)

Convertible Bonds: Use the If Converted Method

Assume conversion on 1/1/16.

              2 Interest not paid net of tax = $108 million [(6% x $3,000 million) x 60%]

3. # additional shares on conversion = 80 million

4. Conversion ratio = $108 ÷ 80 = $1.35

5. Dilutive because $1.35 is less than $1.72.

Basic EPS = ($1,552- $80) ÷ 816 = $1.30

Diluted EPS = (1,552- 90 + 108) ÷ (816 + 30 + 80) = $1.69

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