EPS and Compensation

Topics: Corporate finance, Stock market, Preferred stock Pages: 5 (1042 words) Published: September 17, 2014
 EPS and Compensation

Only applies to common shares

The Issue
EPS is a measure of income earned for each share of common stock EPS = NI – preferred dividends (declared and THIS YEARS cumulative but not declared)
Weighted average number of shares
EPS with a stock dividend =NI – preferred dividends Shares outstanding * split ratio (or 1 + stock dividend %) Example
This year we earned $100,000 and have 50,000 shares of common stock outstanding throughout the year EPS = 100,000/50000 = $2 / share

In addition to the above information, we find that instead of cash, we gave our CFO options to receive 25,000 shares for free in two years as compensation. What is this year’s EPS?

EPS = 100,000/(50,000 + 25,000) = $1.33 / share

Earnings per Share
Basic earnings per share
EPS considering only common stock outstanding at some point during the year Diluted earnings per share
EPS considering potentially dilutive securities in addition to common stock outstanding during the year Examples of potentially dilutive securities
Convertible bonds
Convertible preferred stock
Stock warrants (options)
Stock compensation
Accounting for convertibles
Issuance  same as straight debt or equity
Retirement  same as straight debt or equity
Conversion  Book value approach
What is the book value of the convertible security?
Bond = face value + unamortized premium (or – unamortized discount) Preferred stock = par value + additional paid in capital
Transfer the book value of the convertible to common stock (par and APIC) Stock Warrants
Only detachable warrants have their own value
Use proportional or incremental method to apportion selling price Proportional: have market price for all securities in the package Incremental: missing a market price
Initially, credit goes to APIC – stock warrant

Upon exercise
Dr. Cash
Dr. APIC – stock warrant
Cr. Common Stock
Cr. APIC – Common stock
Basic EPS
Formula:
NI – Preferred Dividends
Weighted average number of common shares outstanding

Definitions:
Net income (also report effect of special items)
Preferred dividends are THIS YEAR’s declared dividends or undeclared cumulative dividends Weighted = number of months
Outstanding = not including treasury stock

Weighted average example
Beginning shares = 1000 – January 1st
Weight = 12/12
Value = 1000
May 30th issue 600 shares
Weight = 7/12
Value = 350
October 1st repurchase 350 shares
Weight = 3/12
Value = (87.50)
Weighted average number of shares outstanding = 1,262.50

Weighted Average
Stock splits and stock dividends require adjustment of all prior balances in weighted average computation Example:
Income = 100,000 and shares all year = 50,000
Suppose there is a 2 for 1 stock split in the middle of the year EPS = 100,000 – 0
50,000 (2)
So EPS = $1
Modified example:
Beginning shares = 1000
May 30th, issue 600 shares
August 1st, 3 for 2 stock split
October 1st, repurchase 350 shares
Denominator:
(1.5)1000 +(1.5) (600 * 7/12) – (350 * 3/12) = 1937.50

Diluted EPS
Takes into account potential dilution
AS IF converted from the beginning of the year
Identify both the numerator and denominator effect
Adjust basic EPS to take into account dilutives
If you have a loss, basic and diluted EPS are the same because dilutive effects become anti-dilutive Steps
What can potentially dilute EPS
Compute basic EPS
Compute the incremental effect of each diluted security
Rank the incremental effects from smallest to largest
Calculate diluted EPS until it is smaller than the next incremental effect At some point, not dilutive anymore
Convertible bonds
What would be different if bonds had been converted at the beginning of the year? No debt on balance sheet
More common stock *
No interest payment *
Add common stock to the denominator
Add back interest, net of tax, to net income
Interest *...
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