277
Chapter 9
For the Investor
QUESTIONS
stock during an accounting period.
earnings per share for nonpublic companies.
applies to corporate income statements.
9- 4. Earnings per share is a concept that only applies to common stock. The
ratio.
9- 5. Since earnings pertain to an entire year, they should be related to the common
of the year that if converted those shares would be outstanding during the year
9- 6. Less preferred dividends will be subtracted from net income in the numerator
used to retire the preferred stock in relation to the dividend decrease.
9- 7. Stock dividends and stock splits do not provide the firm with more funds; they
9- 8. Many firms try to maintain a stable percentage because they have a policy on
9- 9. Financial leverage is the use of financing with a fixed charge. Financial
disadvantageous when a firm obtains a lower return on the resources obtained
than the rate of interest expense.
9-10. If the interest rate rises, the degree of financial leverage will rise. For
example, suppose the firm has the following pattern of earnings with
279
9-14. Book value is based on a mixture of valuation basis, such as historical costs.
9-15. Stock options are a form of potential dilution of earnings. With the requirement
will reduce earnings each year.
9-16. A relatively small number of stock appreciation rights can prove to be a
9-17. If the stock price decreases in relation to the prior year, then the estimate of
total compensation expense related to the stock appreciation rights will
280
PROBLEMS
PROBLEM 9-1
Degree of Financial Leverage
=
Earnings Before Interest, Tax, Noncontrolling
Interest, Equity Income and Nonrecurring Items
Earnings Before Tax, Noncontrolling Interest,
Equity Income, and Nonrecurring Items
$975,000 + $70,000
=
$1,045,000
=
1.07
$975,000
$975,000
PROBLEM 9-2
a.
Degree of Financial Leverage
=
Earnings Before Interest, Tax
Noncontrolling Interest, Equity Income,
and Nonrecurring Items
Earnings Before Tax, Noncontrolling
Interest, Equity Income, and
Nonrecurring Items
=
$1,000,000
$800,000
=
1.25
b.
Prior earnings before interest and tax
$
1,000,000
10% increase
100,000
Adjusted income before interest and tax
$
1,100,000
Interest
200,000
Income before tax
$
900,000
Tax (50% rate)
450,000
Net income
450,000
Earnings will increase by 12.5% to $450,000
($400,000 x 112.5% = $450,000)
c.
$
800,000
Earnings before interest and tax
200,000
Interest
600,000
Earnings before tax
300,000
Tax
$
300,000
Net Income
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PROBLEM 9-3
a.
1.
Percentage of Earnings Retained
=
Net Income – All Dividends
Net Income
2011
2010
2009
Net income (A)
$
31,200,000
$
30,600,000
$
29,800,000
Less:
Common dividend
21,700,000
19,500,000
18,360,000
Preferred dividend
910,000
910,000
910,000
(B)
$
22,610,000
$
20,410,000
$
19,270,000
(A) – (B) = (C)
8,590,000
10,190,000
10,530,000
(C) ÷ (A)
27.53%
33.30%
35.34%
2.
Price/Earnings Ratio
=
Market Price Per Share
Fully Diluted Earnings Per Share
2011
2010
2009
$12.80
$14.00
$16.30
$1.12
$1.20
$1.27
= 11.43
= 11.67
= 12.83
3.
Dividend Payout
=
Dividends Per Common Share
Fully Diluted Earnings Per Share
2011
2010
2009
$0.90
$0.85
$0.82
$1.12
$1.20
$1.27
= 80.36%
= 70.83%
= 64.57%
4.
Dividend Yield
=
Dividends Per Common Share
Market Price Per Common Share
2011
2010
2009
$0.90
$0.85
$0.82
$12.80
$14.00
$16.30
= 7.03%
= 6.07%
= 5.03%
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5.
Book Value Per Share
=
Total Stockholders’ Equity – Preferred Stock Equity
Number of Common Shares Outstanding
2011
2010
2009
Total assets:
$
$1,280,100,000
$
$1,267,200,000
$
1,260,400,000
Less:
Liabilities
(800,400,000)
(808,500,000)
(799,200,000)
Stockholders’ Equity
479,700,000
458,700,000
461,200,000
Less:
Nonredeemable
preferred stock
(15,300,000)
(15,300,000)
(15,300,000)
(A) Common stock
equity
$
$464,400,000
$
$443,400,000
$
$445,900,000
(B) Shares
outstanding end
of year
24,280,000
23,100,000
22,500,000
(A) ÷ (B)
$
$19.13
$
$19.19
$
$19.82
payout, is therefore increasing.
The price/earnings ratio has been relatively stable. The dividend yield has increased
283
PROBLEM 9-4
a.
1.
Percentage of Earnings Retained
=
Net Income – All Dividends
Net Income
2011
2010
2009
Net income (B)
$
9,100,000
$
13,300,000
$
16,500,000
Less:
Cash dividends (A)
(6,080,000)
(5,900,000)
(6,050,000)
$
3,020,000
$
7,400,000
$
10,450,000
(A) ÷ (B)
33.19%
55.64%
63.33%
2.
Price/Earnings Ratio
=
Market Price Per Share
Fully Diluted Earnings Per Share
2011
2010
2009
$41.25
$35.00
$29.00
$2.30
$3.40
$4.54
= 17.93
= 10.29
= 6.39
3.
Dividend Payout
=
Dividends Per Common Share
Fully Diluted Earnings Per Share
2011
2010
2009
$1.90
$1.90
$1.90
$2.30
$3.40
$4.54
= 82.61%
= 55.88%
= 41.85%
4.
Dividend Yield
=
Dividends Per Common Share
Market Price Per Common Share
2011
2010
2009
$1.90
$1.90
$1.90
$41.25
$35.00
$29.00
= 4.61%
= 5.43%
= 6.55%
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5.
Book Value Per Share
=
Market Price Value
Ratio of Market Price to Book Value
2011
2010
2009
$41.25
$35.00
$29.00
120.5%
108.0%
105.0%
= $34.23
= $32.41
= $27.62
payout, materially increased.
The price earnings ratio materially increased, which is difficult to explain, considering
The increase in market price and the increase in price earnings ratio appears to be
285
PROBLEM 9-5
Simple Earnings Per Share
=
Net Income – Preferred Dividends
Weighted Average Number of
Common Shares Outstanding
Year 1
Year 2
$40,000 – $22,500
$42,000 – $27,500
38,000
38,000
$0.46
$0.38
The decline in earnings per share is caused mainly by the issuance of preferred
stock.
PROBLEM 9-6
January 1, shares outstanding
50,000
shares
July 1, two-for-one stock split
2
Adjusted shares outstanding for the year
(A)
100,000
October 1 stock issue
10,000
shares
Proportion of year that the new shares were
outstanding
0.25
Weighted average for the new shares on an annual
basis
(B)
2,500
Denominator of the earnings per share
computation for the current year
(A) + (B)
102,500
PROBLEM 9-7
Revision of 2010 earnings per share:
2010 reported earnings per share
$
2.00
July 1, 2011 stock split
x 0.5
Adjusted 2010 earnings per share
$
1.00
December 31, 2011 stock split
x 0.5
Adjusted 2010 earnings per share
$
0.50
Earnings Per Share
Numerator
Net income
$
35,000
Preferred dividends
Earnings per share
$1.56
$
27,000
20,500
Recurring earnings per share
$1.32