Question 4.18: A Diluted EPS Calculation Using the Treasury Stock Method fo...
A Diluted EPS Calculation Using the Treasury Stock Method for Options
Hihotech Company reported net income of $2.3 million for the year ended 30 June 2005 and had an average of 800,000 common shares outstanding. The company has outstanding 30,000 options with an exercise price of $35 and no other potentially dilutive securities. Over the year, the company’s market price has averaged $55 per share. Calculate the company’s basic and diluted EPS.
Using the treasury stock method, we first calculate that the company would have received $1,050,000 ($35 for each of the 30,000 options exercised) if all the options had been exercised. The options would no longer be outstanding; instead, 30,000 new shares of common stock would be outstanding. Under the treasury stock method, we reduce the number of new shares by the number of shares that could have been purchased with the cash received upon exercise of the options. At an average market price of $55 per share, the $1,050,000 proceeds from option exercise could have purchased 19,091 shares of treasury stock. Therefore, the net new shares issued would have been 10,909 (calculated as 30,000 minus 19,091). No change is made to the numerator. As shown in Exhibit 4-11, the company’s basic EPS was $2.88 and the diluted EPS was $2.84.
EXHIBIT 4-11 Calculation of Diluted EPS for Hihotech Company
| Using the If-Converted Method: Case of Preferred Stock | ||
| Basic EPS | Diluted EPS Using Treasury Stock Method |
|
| Net income | $2,300,000 | $2,300,000 |
| Numerator | $2,300,000 | $2,300,000 |
| Weighted average number of shares outstanding | 800,000 | 800,000 |
| If converted | 0 | 10,909 |
| Denominator | 800,000 | 810,909 |
| EPS | $2.88 | $2.84 |