Incentive stock options to purchase 40 million shares of common stock after July
ID: 2477894 • Letter: I
Question
Incentive stock options to purchase 40 million shares of common stock after July 1, 2015, at $14 per share were outstanding at the beginning and end of 2016. The average market price of Canaday’s common stock was $20 per share during 2016.
Canaday's net income for the year ended December 31, 2016, was $1,500 million. The effective income tax rate was 40%.
Calculate basic and diluted earnings per common share for the year ended December 31, 2016. (Enter your answers in millions (i.e., 10,000,000 should be entered as 10).)
Numerator / Demominator = Earnings per share
Basic
Diluted
At January 1, 2016, Canaday Corporation had outstanding the following securities:Explanation / Answer
Calculate the basic and diluted EPS for the year ended December 31,2016
Numerator (Basic EPS): Net income = $1,500 million; Preferred dividends = $60 million [(6% x $50) x 20 million]. Because the preferred stock is cumulative dividends are included whether or not preferred stock is cumulative, dividends are included whether or not paid.Denominator (Basic EPS): Weighted average # shares common stock outstanding
1/1 – 12/31 660 million x (12/12) = 660
9/1 – 12/31 72 million x (4/12) = 24
Weighted average # shares 684
Basic EPS = ($1,500 - $60) ÷ 684 = $2.10
Stock Options: Use the Treasury Stock Method if dilutive.
1. Are the stock options dilutive? Yes because the exercise price of $14 is less than the average market price of $20.
2. Assume exercise at the later of the date of issue (7/1/12) or thebeginning of the period (1/1/13). Assume exercise 1/1/13.
3. Proceeds received on exercise = 40 million x $14 = $560 million
4. # Shares repurchased = $560 million ÷ $20 = 28 million
5. Net increase in # shares outstanding = 12 million (40 million – 28 million)
6. EPS with the inclusion of the options: ($1,500 - $60) ÷ (684 + 12) = $2.06 (this will be used to test for dilutive effect of convertible bonds).
Convertible Bonds: Use the If Converted Method
1. Assume conversion at later of date of issue (?) or beginning of year (1/1/13). Assume conversion on 1/1/13.
2 Interest not paid net of tax = $126 million [(6% x $3,500 million) x60%
3. # additional shares on conversion = 70 million
4. Conversion ratio = $126 ÷ 70 = $1.80
5. Dilutive because $1.80 is less than $2.06
Basic EPS = ($1500 - $60) ÷ 684 = $2.10
Diluted EPS = ($1,500 - $60 + $126) ÷ (684 + 70 + 12) = $2.04 .