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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

(EPS with Stock Dividend and Discontinued Operations) Christina Corporation is preparing the comparative financial statements to be included in the annual report to stockholders. Christina employs a fiscal year ending May 31.

Income from operations before income taxes for Christina was \(1,400,000 and \)660,000, respectively, for fiscal years ended May 31, 2018 and 2017. Christina experienced a loss from discontinued operations of \(400,000 on March 3, 2018. A 40% combined income tax rate pertains to any and all of Christina Corporation’s profits, gains, and losses.

Christina’s capital structure consists of preferred stock and common stock. The company has not issued any convertible securities or warrants and there are no outstanding stock options.

Christina issued 40,000 shares of \)100 par value, 6% cumulative preferred stock in 2014. All of this stock is outstanding, and no preferred dividends are in arrears.

There were 1,000,000 shares of \(1 par common stock outstanding on June 1, 2016. On September 1, 2016, Christina sold an additional 400,000 shares of the common stock at \)17 per share. Christina distributed a 20% stock dividend on the common shares outstanding on December 1, 2017. These were the only common stock transactions during the past 2 fiscal years.

Instructions

(a) Determine the weighted-average number of common shares that would be used in computing earnings per share on the current comparative income statement for:

(1) The year ended May 31, 2017.

(2) The year ended May 31, 2018.

(b) Starting with income from operations before income taxes, prepare a comparative income statement for the years ended May 31, 2018 and 2017. The statement will be part of Christina Corporation’s annual report to stockholders and should include appropriate earnings per share presentation.

(c) The capital structure of a corporation is the result of its past financing decisions. Furthermore, the earnings per share data presented on a corporation’s financial statements is dependent upon the capital structure.

(1) Explain why Christina Corporation is considered to have a simple capital structure.

(2) Describe how earnings per share data would be presented for a corporation that has a complex capital structure.

(Issuance of Bonds with Warrants) Illiad Inc. has decided to raise additional capital by issuing \(170,000 face value of bonds with a coupon rate of 10%. In discussions with investment bankers, it was determined that to help the sale of the bonds, detachable stock warrants should be issued at the rate of one warrant for each \)100 bond sold. The value of the bonds without the warrants is considered to be \(136,000, and the value of the warrants in the market is \)24,000. The bonds sold in the market at issuance for $152,000.

Instructions

(a) What entry should be made at the time of the issuance of the bonds and warrants?

(b) If the warrants were nondetachable, would the entries be different? Discuss.

Rockland Corporation earned net income of \(300,000 in 2017 and had 100,000 shares of common stock outstanding throughout the year. Also outstanding all year was \)800,000 of 9% bonds, which are convertible into 16,000 shares of common. Rockland’s tax rate is 40%. Compute Rockland’s 2017 diluted earnings per share.

Bedard Corporation reported net income of \(300,000 in 2017 and had 200,000 shares of common stock outstanding throughout the year. Also outstanding all year were 45,000 options to purchase common stock at \)10 per share. The average market price of the stock during the year was $15. Compute diluted earnings per share.

Ferraro, Inc. established a stock-appreciation rights (SARs) program on January 1, 2017, which entitles executives to receive cash at the date of exercise for the difference between the market price of the stock and the pre-established price of \(20 on 5,000 SARs. The required service period is 2 years. The fair value of the SARs are determined to be \)4 on December 31,2017, and $9 on December 31, 2018. Compute Ferraro’s compensation expense for 2017 and 2018.

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