Question

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

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

Step-by-step solution

(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.

(b) Computation of basic earnings per share:

Net Income	$360,000
Average share outstanding	100,000
Basic Earnings Per share	$3.60

Computation of Diluted Earnings Per Share:

$\begin{array}{rcl}\mathbf{Incremental}\mathbf{}\mathbf{share}& \mathbf{=}& \frac{\mathbf{Market}\mathbf{}\mathbf{price}\mathbf{-}\mathbf{Option}\mathbf{}\mathbf{Price}}{\mathbf{Market}\mathbf{}\mathbf{price}}\mathbf{\times }\mathbf{Number}\mathbf{}\mathbf{of}\mathbf{}\mathbf{warrants}\\ & \mathbf{=}& \frac{\mathbf{15}-\mathbf{10}}{\mathbf{15}}\mathbf{\times }\mathbf{15}\mathbf{,}\mathbf{000}\\ & \mathbf{=}& \mathbf{5000}\\ & & \end{array}$

Net Income	$360,000
Average share outstanding (100,000+5000)	105 000
Basic Earnings Per share	$3.43