2. Learning Outcomes
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Recognise the importance of comparability in relation to the calculation of earnings
per share (EPS) and its importance as a stock market indicator
Explain why the trend of EPS may be a more accurate indicator of performance
than a companyâs profit trend
Define earnings
Calculate the EPS in the following circumstances:
â basic EPS
â where there has been a bonus issue of shares/stock split during the year, and
â where there has been a rights issues of shares during the year
Explain the relevance to existing shareholders of the diluted EPS, and describe the
circumstances that will give rise to a future dilution of the EPS
Compute the diluted EPS in the following circumstances:
â where convertible debt or preference shares are in issue
â where share options and warrants exist
Identify anti-dilutive circumstances
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3. Earnings Per Share
Earnings Per Share (EPS) is the amount which an entity has earned per share
for the given period. It is calculated as a ratio of earnings to the number of
shares issued.
EPS = Profit after tax / Total shares outstanding
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4. Why EPS is important
K Ltd has earned a profit of $800,000 and $1 million during 2011 and 2012
respectively. The number of shares outstanding during 2005 and 2006 are
1,000,000 and 1,600,000 respectively.
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5. Average profits and number of shares
K Ltd has earned profit of $1 million during 2011. Number of shares
outstanding on 31st December 2011 (reporting date) are 1,000,000. There were
issued 600,000 shares on 31st May 2011 and 100,000 shares were bought back
on 30th September 2011.
Calculate the EPS in above case.
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6. Bonus Issue
The EPS in case of bonus shares is calculated as if these bonus shares were
always available. If this is not done, the EPS calculations would be incorrect
and would not be comparable.
⢠K Ltd had a share capital of 20 million shares of $1 each on 1st January
2011. It issued 1 bonus share against 4 existing shares on 30th June 2011.
The profits for the year ending 31st December 2012 and 31st December
2011 were $75 million and $60 million respectively.
⢠You are required to calculate the EPS for both 2011 and 2012.
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7. Stock Split
K Ltd had a share capital of 2 million shares of $10 each on 1st January 2011.
On 1st July 2011, K Ltd splits one $10 share into 5 shares of $2 each. The
profits for the year ending 31st December 2012 and 31st December 2011 were
$75 million and $60 million respectively.
You are required to calculate the EPS for both 2011 and 2012.
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8. Right Issue
ďą Bonus element is included
ďą Some amount recovered from existing shareholders
Number of shares is calculated as:
Fair value of shares immediately before the exercise of rights / Theoretical exrights fair value per share
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9. Theoretical ex-rights price
(Fair value of all outstanding shares before exercise of rights + total amount
received from exercise of rights) /
(Number of shares outstanding before exercise + number of shares issued in
the exercise)
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10. Example
K Ltd has an issued capital of 2 million shares of $10 each. It makes a right
issue of 1 share against 2 shares held on 30th September 2011 at $15 per share.
Fair value of the shares is $25 per share.
Calculate the theoretical ex-rights price.
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11. Example
⢠Profits during
2009
3 million
2010
3.5 million
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2011
4.2 million
No. of shares outstanding at rights issue = 1 million
K Ltd had issued 1 share against 4 outstanding shares for right issue.
Exercise price = $6 per share
Issuance date = 31st January 2010
Last date for exercise of rights = 1st March 2010
Fair value of a share on 1st March 2010 is $12 (just prior to exercise of
right).
You are required to calculate the EPS on 31st December 2009, 2010 and 2011.
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12. Diluted EPS
Dilution is a reduction in earnings per share or an increase in loss per share
resulting from the assumption that convertible instruments are converted, that
options or warrants are exercised, or that ordinary shares are issued upon the
satisfaction of specified conditions.
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13. Example
K Ltd issued 100,000 8% debentures of $10 each. Each debenture is
convertible into 8 shares of $1 each. Tax rate as applicable to K Ltd is 30%.
Earnings available to ordinary shareholders are $750,000. K Ltd has
1,000,000 shares outstanding before conversion.
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14. Anti-dilution
⢠Anti-dilution is an increase in the earnings per share or a reduction in loss
per share resulting from an assumption that convertible instruments are
converted, that options or warrants are exercised, or that ordinary shares are
issued upon the satisfaction of specified condition.
⢠Since as a result of potential conversion the EPS increases, the potential
conversion is ignored for the purposes of diluted EPS.
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15. Example
K Ltd issued 100,000 10% debentures of $1 each. 100 debentures are
convertible into 10 share of $10 each. Tax rate as applicable to K Ltd is 10%.
Earnings available to ordinary shareholders are $750,000. K Ltd has 100,000
shares outstanding before conversion.
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16. Example
⢠K Ltd earned a profit after tax of $390 million during the year 2011. The
weighted average number of shares outstanding during the year was 260
million.
⢠The following details are relevant for the potential shares:
⢠K Ltd issued preference shares convertible into 12 million ordinary shares
after 5 years. Dividend paid on these shares during the year was $7.5
million.
⢠K Ltd issued convertible debt (interest on debt paid during the year of $25
million) which upon conversion would increase the number of shares by 9
million.
⢠K Ltd issued options carrying the right to acquire 4 million shares at a
price of $9 per share. During the year, market price of the share was $10
per share.
⢠Tax applicable to K Ltd is 20%.
You are required to calculate Basic and Diluted EPS.
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