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E16-28 (L05) (EPS with Warrants) Howat Corporation earned \(360,000 during a period when it had an average of 100,000 shares of common stock outstanding. The common stock sold at an average market price of \)15 per share during the period. Also outstanding were 15,000 warrants that could be exercised to purchase one share of common stock for $10 for each warrantexercised.

Instructions

(a) Are the warrants dilutive?

(b) Compute basic earnings per share.

(c) Compute diluted earnings per share.

Short Answer

Expert verified
  1. Yes, the warrants are dilutive.
  2. Basic Earnings per share $3.60
  3. Diluted Earnings per Share $3.43

Step by step solution

01

(a) Explanation on dilutive warrants

The warrants are dilutive in light of the fact that it allows its holders to change over it into a common stock. Also the option price of $10 is lower than the average market price of $15.

02

(b) Computation of basic earnings per share:

Net Income

$360,000

Average share outstanding

100,000

Basic Earnings Per share

$3.60

03

Computation of Diluted Earnings Per Share:

Incrementalshare=Marketprice-OptionPriceMarketprice×Numberofwarrants=15-1015×15,000=5000

Net Income

$360,000

Average share outstanding (100,000+5000)

105 000

Basic Earnings Per share

$3.43

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Most popular questions from this chapter

GROUPWORK (Entries for Various Dilutive Securities) The stockholders’ equity section of Martino Inc. at the beginning of the current year appears below.

Common stock, \(10 par value, authorized 1,000,000

shares, 300,000 shares issued and outstanding \)3,000,000

Paid-in capital in excess of par—common stock 600,000

Retained earnings 570,000

During the current year, the following transactions occurred.

1. The company issued to the stockholders 100,000 rights. Ten rights are needed to buy one share of stock at \(32. The rights were void after 30 days. The market price of the stock at this time was \)34 per share.

2. The company sold to the public a \(200,000, 10% bond issue at 104. The company also issued with each \)100 bond one detachable stock purchase warrant, which provided for the purchase of common stock at \(30 per share. Shortly after issuance, similar bonds without warrants were selling at 96 and the warrants at \)8.

3. All but 5,000 of the rights issued in (1) were exercised in 30 days.

4. At the end of the year, 80% of the warrants in (2) had been exercised, and the remaining were outstanding and in good standing.

5. During the current year, the company granted stock options for 10,000 shares of common stock to company executives.

The company, using a fair value option-pricing model, determines that each option is worth \(10. The option price is \)30.

The options were to expire at year-end and were considered compensation for the current year.

6. All but 1,000 shares related to the stock-option plan were exercised by year-end. The expiration resulted because one of the executives failed to fulfill an obligation related to the employment contract.

Instructions

(a) Prepare general journal entries for the current year to record the transactions listed above.

(b) Prepare the stockholders’ equity section of the balance sheet at the end of the current year. Assume that retained earnings

at the end of the current year is $750,000.

Explain how the conversion feature of convertible debt has a value (a) to the issuer and (b) to the purchaser.

Assume that Sarazan Company has a share-option plan for top management. Each share option represents the right to purchase a \(1 par value ordinary share in the future at a price equal to the fair value of the shares at the date of the grant. Sarazan has 5,000 share options outstanding, which were granted at the beginning of 2017. The following data relate to the option grant.

Exercise price for options \)40

Market price at grant date (January 1, 2017) \(40

Fair value of options at grant date (January 1, 2017) \)6

Service period 5 years

Instructions

(a) Prepare the journal entry(ies) for the first year of the share-option plan.

(b) Prepare the journal entry(ies) for the first year of the plan assuming that, rather than options, 700 shares of restricted shares were granted at the beginning of 2017.

(c) Now assume that the market price of Sarazan shares on the grant date was $45 per share. Repeat the requirements for (a) and (b).

(d) Sarazan would like to implement an employee share-purchase plan for rank-and-file employees, but it would like to avoid recording expense related to this plan. Explain how employee share-purchase plans are recorded?

Explain how convertible securities are determined to be potentially dilutive common shares and how those convertible securities that are not considered to be potentially dilutive common shares enter into the determination of earnings per share data.

Discuss why options and warrants may be considered potentially dilutive common shares for the computation of diluted earnings per share.

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