Question 1

Explain the "income effect" and "share effect" as they apply to the calculation of incremental EPS.

Accepted Answer

The answer of Explain the "income effect" and "share effect"...

Question 2

Calculate the incremental EPS for the following instrument: Face value of 10,000 preferred shares with dividend rate of 5%
$1,000,000
Conversion rate for each preferred share
25 ordinary shares
Income tax rate
30%

Accepted Answer

The answer of Calculate the incremental EPS for the following...

Question 3

Know Your Rights Co. has three stock option plans outstanding on December 31, 2020. They provide the holders with the following entitlements:
• Stock option A-The holders may purchase 55,000 ordinary shares at any time on or before December 31, 2024 for $41 each.
• Stock option B-The holders may purchase 2,000 ordinary shares at any time on or before December 31, 2021 for $47 each. From January 1, 2022 to December 31, 2024 the holders may purchase 7,000 ordinary shares for $52 each.
• Stock option C-The holders may purchase 12,000 ordinary shares at any time on or before December 31, 2022 for $51 each.
The average price of ordinary shares in 2020 was $50 and its basic EPS from continuing operations for the year was $1.01.
Required:
a. Which of the stock options are dilutive and which are antidilutive in 2020? What is the rule in this respect?
b. Assuming that all three option plans have been in place the entire year, for each plan, determine the incremental number of shares, if any, that need to be considered for diluted EPS purposes.
c. Assume that stock option A was issued on April 1, 2020. Does this change your answer to part b? If so, what is the revised number of incremental shares for option A that need to be considered for diluted EPS purposes?

Accepted Answer

The answer of Know Your Rights Co. has three stock...

Question 4

Since, the objective of reporting diluted EPS is to provide the lowest possible EPS figure, we include all dilutive POS but exclude any antidilutive POS. What are the four steps in the process to separate dilutive from antidilutive POS and to calculate diluted EPS?

Accepted Answer

The answer of Since, the objective of reporting diluted EPS...

Question 5

Calculate the income effect on the incremental EPS for the following instrument: Face value of 50,000 preferred shares with dividend rate of 5%
$5,000,000
Conversion rate for each preferred share
5 ordinary shares
Income tax rate
30%

Accepted Answer

The answer of Calculate the income effect on the incremental...

Question 6

Which statement is correct?

Accepted Answer

In the money stock options are the most dilutive because they are already profitable for the holder to convert into stock at the current market price, leading to an increase in the number of shares outstanding and dilution of existing shareholders' equity.

Question 7

What is the meaning of "at-the-money options"?

Accepted Answer

At-the-money options refer to the situation when the market price of the underlying asset equals the exercise price. This means that if an option is exercised at this point, the investor would not make a profit or loss.

Question 8

Calculate the share effect on the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 5% and coupon rate of 5%
$2,000,000
Issue date
January 1, 2021
Maturity date
December 31, 2028
Conversion rate for each $1,000 bond
40 ordinary shares
Income tax rate
25%

Accepted Answer

The share effect on incremental EPS is calculated by dividing the interest saved (after tax) by the number of shares created upon conversion. The interest saved is $2,000,000 * 5% * (1 - 0.25) = $75,000. The number of shares created is ($2,000,000 / $1,000) * 40 = 80,000 shares. Therefore, the share effect is $75,000 / 80,000 = 0.9375, which rounds to 0.94.

Question 9

Which statement is correct about diluted EPS?

Accepted Answer

Diluted EPS includes the impact of all potentially dilutive securities. The incremental EPS of the most dilutive item, i.e. the item with the greatest impact on EPS, is compared to the basic EPS to determine if it is dilutive or anti-dilutive. If the incremental EPS is lower than the basic EPS, the item is anti-dilutive and is therefore not included in diluted EPS calculations.

Question 10

Calculate the income effect on the incremental EPS for the following instrument: Convertible bonds outstanding, effective yield of 7% and coupon rate of 7%
$2,000,000
Issue date
January 1, 2021
Maturity date
December 31, 2024
Conversion rate for each $1,000 bond
20 ordinary shares
Income tax rate
25%

Accepted Answer

The answer of Calculate the income effect on the incremental...

Question 11

Which statement is correct?

Accepted Answer

When the right to convert convertible securities expires during the year, the income effect and share effect are pro-rated for the diluted EPS calculation. This is because the impact of these securities on diluted EPS is only applicable during the period when they can be converted into common shares. When this right expires, the impact of the securities on diluted EPS is no longer relevant, and therefore their effects must be pro-rated for the time period when they were still applicable. The other answer choices are incorrect because they either suggest that the income and share effects are not pro-rated at all (A and B) or that they are pro-rated from the beginning of the year (D).

Question 12

Explain why only in-the-money options need be considered in the diluted EPS calculations.

Accepted Answer

The answer of Explain why only in-the-money options need be...

Question 13

The net income for Cedarsprings Retreat Centre for the year ended December 31, 2020, was $800,000. Cedarsprings had 50,000 ordinary shares outstanding at the beginning of the year. Cedarsprings declared and distributed a three-for-one stock split on May 1, 2020 and issued (sold)30,000 ordinary shares on November 1, 2020. Select details of Cedarsprings' liabilities and equities follow:
Bonds A-$2,000,000, 6%, 10-year, semi-annual bonds issued on July 1, 2020. At the option of the holder, each $1,000 bond can be converted into 14 ordinary shares at any time before expiry.
Bonds B-$2,000,000, 5%, semi-annual bonds maturing September 30, 2024. The owners of the bonds elect to convert them into 12,000 ordinary shares on December 1, 2020.
200,000 cumulative preferred shares that are each entitled to dividends of $2.00 per annum. Dividends are not declared in 2020. Cedarsprings' corporate tax rate was 40%. The recorded conversion factor for the convertible bonds has already been adjusted for the stock split.
Required: Assuming that the effective rate of interest on the bonds equals the coupon rate:
a)Calculate Cedarsprings' basic earnings per share for 2020.
b)Prepare a schedule that sets out the income effect, share effect, and incremental EPS for each security that is convertible into ordinary shares. Rank the potential ordinary shares by their dilutiveness.
c)Calculate Cedarsprings' diluted earnings per share for 2020.

Accepted Answer

The answer of The net income for Cedarsprings Retreat Centre...

Question 14

Calculate the share effect on the incremental EPS for the following instrument: Face value of 50,000 preferred shares with dividend rate of 5%
$5,000,000
Conversion rate for each preferred share
5 ordinary shares
Income tax rate
30%

Accepted Answer

The share effect on incremental EPS is calculated by multiplying the number of preferred shares by the conversion rate: 50,000 shares * 5 ordinary shares = 250,000 ordinary shares.

Question 15

Calculate the income effect on the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 6% and coupon rate of 6%
$2,000,000
Issue date
January 1, 2021
Maturity date
December 31, 2028
Conversion rate for each $1,000 bond
20 ordinary shares
Income tax rate
25%

Accepted Answer

The income effect is calculated as the interest saved due to conversion, which is $2,000,000 * 6% = $120,000. After tax, this is $120,000 * (1 - 0.25) = $90,000.

Question 16

Calculate the incremental EPS for the following instrument: Face value of 10,000 preferred shares with dividend rate of 5%
$5,000,000
Conversion rate for each preferred share
25 ordinary shares
Income tax rate
30%

Accepted Answer

The incremental EPS is calculated by dividing the net income attributable to the new ordinary shares by the number of new ordinary shares. The preferred dividend is $500,000 (5% of $10,000,000). The conversion results in 250,000 new ordinary shares (10,000 shares * 25). The incremental EPS is $500,000 / 250,000 = $2.00.

Question 17

Describe the procedure for identifying dilutive and antidilutive potential ordinary shares and calculating diluted EPS.

Accepted Answer

The answer of Describe the procedure for identifying dilutive and...

Question 18

Explain the purpose of incremental EPS.

Accepted Answer

The answer of Explain the purpose of incremental EPS....

Question 19

What is the meaning of "out-of-the-money warrants"?

Accepted Answer

Out-of-the-money warrants refer to warrants whose exercise price is higher than the current market price of the underlying asset, which makes it unprofitable to exercise the warrant. In other words, the holder of the warrant would not gain by buying the asset at the higher exercise price when the market price is below it. Hence, the market price of the share is less than the exercise price, making option B the correct answer.

Question 20

What is the formula for diluted EPS? What are dilutive and antidilutive potential ordinary shares and how do they each impact the computation of dilutes EPS?

Accepted Answer

The answer of What is the formula for diluted EPS?...

Quiz 5: Earnings Per Share

Explain the "income effect" and "share effect" as they apply to the calculation of incremental EPS.

Calculate the incremental EPS for the following instrument: Face value of 10,000 preferred shares with dividend rate of 5% $1,000,000 Conversion rate for each preferred share 25 ordinary shares Income tax rate 30%

Since, the objective of reporting diluted EPS is to provide the lowest possible EPS figure, we include all dilutive POS but exclude any antidilutive POS. What are the four steps in the process to separate dilutive from antidilutive POS and to calculate diluted EPS?

Calculate the income effect on the incremental EPS for the following instrument: Face value of 50,000 preferred shares with dividend rate of 5% $5,000,000 Conversion rate for each preferred share 5 ordinary shares Income tax rate 30%

Which statement is correct?

What is the meaning of "at-the-money options"?

Calculate the share effect on the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 5% and coupon rate of 5% $2,000,000 Issue date January 1, 2021 Maturity date December 31, 2028 Conversion rate for each $1,000 bond 40 ordinary shares Income tax rate 25%

Which statement is correct about diluted EPS?

Which statement is correct?

Explain why only in-the-money options need be considered in the diluted EPS calculations.

Calculate the share effect on the incremental EPS for the following instrument: Face value of 50,000 preferred shares with dividend rate of 5% $5,000,000 Conversion rate for each preferred share 5 ordinary shares Income tax rate 30%

Calculate the income effect on the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 6% and coupon rate of 6% $2,000,000 Issue date January 1, 2021 Maturity date December 31, 2028 Conversion rate for each $1,000 bond 20 ordinary shares Income tax rate 25%

Calculate the incremental EPS for the following instrument: Face value of 10,000 preferred shares with dividend rate of 5% $5,000,000 Conversion rate for each preferred share 25 ordinary shares Income tax rate 30%

Describe the procedure for identifying dilutive and antidilutive potential ordinary shares and calculating diluted EPS.

Explain the purpose of incremental EPS.

What is the meaning of "out-of-the-money warrants"?

What is the formula for diluted EPS? What are dilutive and antidilutive potential ordinary shares and how do they each impact the computation of dilutes EPS?