Question

(EPS with Complex Capital Structure) Amy Dyken, controller at Fitzgerald Pharmaceutical Industries, a public company, is currently preparing the calculation for basic and diluted earnings per share and the related disclosure for Fitzgerald’s financial statements. Below is selected financial information for the fiscal year ended June 30, 2017.

FITZGERALD PHARMACEUTICAL INDUSTRIES

SELECTED BALANCE SHEET

INFORMATION

JUNE 30, 2017

Long-term debt

Notes payable, 10% \( 1,000,000

8% convertible bonds payable 5,000,000

10% bonds payable 6,000,000

Total long-term debt \)12,000,000

Shareholders’ equity

Preferred stock, 6% cumulative, \(50 par value,

100,000 shares authorized, 25,000 shares issued

and outstanding \) 1,250,000

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

1,000,000 shares issued and outstanding 1,000,000

Additional paid-in capital 4,000,000

Retained earnings 6,000,000

Total shareholders’ equity \)12,250,000

The following transactions have also occurred at Fitzgerald.

1. Options were granted on July 1, 2016, to purchase 200,000 shares at \(15 per share. Although no options were exercised

during fiscal year 2017, the average price per common share during fiscal year 2017 was \)20 per share.

2. Each bond was issued at face value. The 8% convertible bonds will convert into common stock at 50 shares per \(1,000

bond. The bonds are exercisable after 5 years and were issued in fiscal year 2016.

3. The preferred stock was issued in 2016.

4. There are no preferred dividends in arrears; however, preferred dividends were not declared in fiscal year 2017.

5. The 1,000,000 shares of common stock were outstanding for the entire 2017 fiscal year.

6. Net income for fiscal year 2017 was \)1,500,000, and the average income tax rate is 40%.

Instructions

For the fiscal year ended June 30, 2017, calculate the following for Fitzgerald Pharmaceutical Industries.

(a) Basic earnings per share.

(b) Diluted earnings per share.

Short answer

(a) Basic Earnings per share$1.425

(b) Dilutive earnings per share is $1.28

Step-by-step solution

Introduction to the basic earnings per share

Basic earnings per share (EPS) lets financial investors know the amount allocated to each share of common stock from the company's net income.

Step 2:Computation of Basic Earnings per share

Net Income	$1,500,000
Less: Preference dividend$\mathbf{(}\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{250}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{6}\mathbf{\%}\mathbf{)}$	($75,000)
Earnings available to common stockholders (A)	$1,425,000
Weighted average common shares (B)	$1,000,000
Basic Earnings Per Share (A)/(B)	$1.425

Computation of Diluted Earnings per share

$\begin{array}{c}\mathbf{D}\mathbf{i}\mathbf{l}\mathbf{u}\mathbf{t}\mathbf{e}\mathbf{d}\mathbf{e}\mathbf{a}\mathbf{r}\mathbf{n}\mathbf{i}\mathbf{n}\mathbf{g}\mathbf{s}\mathbf{p}\mathbf{e}\mathbf{r}\mathbf{s}\mathbf{h}\mathbf{a}\mathbf{r}\mathbf{e}\mathbf{=}\frac{\mathbf{N}\mathbf{e}\mathbf{t}\mathbf{i}\mathbf{n}\mathbf{c}\mathbf{o}\mathbf{m}\mathbf{e}\mathbf{-}\mathbf{P}\mathbf{r}\mathbf{e}\mathbf{f}\mathbf{e}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{d}\mathbf{d}\mathbf{i}\mathbf{v}\mathbf{i}\mathbf{d}\mathbf{e}\mathbf{n}\mathbf{d}\mathbf{s}\mathbf{+}\mathbf{I}\mathbf{n}\mathbf{t}\mathbf{e}\mathbf{r}\mathbf{e}\mathbf{s}\mathbf{t}\mathbf{\left(}\mathbf{N}\mathbf{e}\mathbf{t}\mathbf{o}\mathbf{f}\mathbf{t}\mathbf{a}\mathbf{x}\mathbf{\right)}}{\mathbf{W}\mathbf{e}\mathbf{i}\mathbf{g}\mathbf{h}\mathbf{t}\mathbf{e}\mathbf{d}\mathbf{n}\mathbf{u}\mathbf{m}\mathbf{b}\mathbf{e}\mathbf{r}\mathbf{o}\mathbf{f}\mathbf{s}\mathbf{h}\mathbf{a}\mathbf{r}\mathbf{e}\mathbf{s}\mathbf{o}\mathbf{u}\mathbf{t}\mathbf{s}\mathbf{t}\mathbf{a}\mathbf{n}\mathbf{d}\mathbf{i}\mathbf{n}\mathbf{g}\mathbf{+}\mathbf{d}\mathbf{i}\mathbf{l}\mathbf{u}\mathbf{t}\mathbf{i}\mathbf{v}\mathbf{e}\mathbf{c}\mathbf{o}\mathbf{m}\mathbf{m}\mathbf{o}\mathbf{n}\mathbf{s}\mathbf{h}\mathbf{a}\mathbf{r}\mathbf{e}\mathbf{s}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{500}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{75}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{400}\mathbf{,}\mathbf{000}\mathbf{(}\mathbf{1}\mathbf{-}\mathbf{0}\mathbf{.}\mathbf{40}\mathbf{)}}{\mathbf{1}\mathbf{,}\mathbf{300}\mathbf{,}\mathbf{000}}\\ \mathbf{=}\mathbf{1}\mathbf{.}\mathbf{28}\end{array}$

Working note:

Weighted average no of shares
Original	1000,000
Add: New issued
Bonds$\mathbf{(}\frac{\mathbf{\$}\mathbf{5000}\mathbf{,}\mathbf{000}}{\mathbf{1000}}\mathbf{\times }\mathbf{50}\mathbf{s}\mathbf{h}\mathbf{a}\mathbf{r}\mathbf{e}\mathbf{s}\mathbf{)}$	250,000
Stock option$\mathbf{(}\mathbf{200}\mathbf{,}\mathbf{000}\mathbf{-}\frac{\mathbf{\$}\mathbf{3}\mathbf{,}\mathbf{000}\mathbf{,}\mathbf{000}}{\mathbf{20}}\mathbf{)}$	50,000
	1300,000