Chapter 19
Illustrated Solution: Problem 19-28
Diluted Earnings
Per Share—Complex
Capital Structure
19-1
Weighted Average Shares Outstanding
19-2

Weighted average shares outstanding are
computed by multiplying the number of shares
outstanding for each month by 1/12 and adding up
the total for twelve months.
Weighted Average Shares Outstanding
19-3

Weighted average shares outstanding are
computed by multiplying the number of shares
outstanding for each month by 1/12 and adding up
the total for twelve months.
Weighted-average common shares outstanding:
Jan. 1 to Sept. 1—280,000 x 8/12………..
186,667
Sept. 1 to Dec. 31—336,000 x 4/12………
112,000
298,667
Net Income Applicable to Common Stock
19-4

Net income applicable to common stock is
computed by adjusting the net income reported on
the income statement by any dividends paid on
preferred stock.
Net Income Applicable to Common Stock
19-5

Net income applicable to common stock is
computed by adjusting the net income reported on
the income statement by any dividends paid on
preferred stock.
Net income………………………………………………
$860,000
Less: Dividends on preferred stock (10,000 x $5) ….
50,000
Net income applicable to common stock…………….
$810,000
Basic Earnings Per Share
19-6

Basic Earnings Per Share is computed by dividing
the net income applicable to common stock by the
weighted average of common shares outstanding
for the period.
Basic Earnings Per Share
19-7

Basic Earnings Per Share is computed by dividing
the net income applicable to common stock by the
weighted average of common shares outstanding
for the period.
Net income applicable to common stock………………
$810,000
Weighted-average shares outstanding………………..
$298,667
Basic EPS ($810,000  298,667)………………………
$2.71
Dilutive Securities
19-8
A convertible security is dilutive if the incremental
earnings per share that would result from
conversion to common stock is lower than the
basic earnings per share without conversion.
Convertible Bonds--Dilutive
19-9
Interest, net of tax, per $1,000 bond ($1,000 x .10 x .70)……..
$70.00
Convertible Bonds--Dilutive
19-10
Interest, net of tax, per $1,000 bond ($1,000 x .10 x .70)……..
$70.00
Number of shares………………………………………………….  40.00
Convertible Bonds--Dilutive
19-11
Interest, net of tax, per $1,000 bond ($1,000 x .10 x .70)……..
$70.00
Number of shares………………………………………………….  40.00
Incremental Earnings Per Share ($70  $40)…………………..
$ 1.75
Convertible Bonds--Dilutive
19-12
Interest, net of tax, per $1,000 bond ($1,000 x .10 x .70)……..
$70.00
Number of shares………………………………………………….  40.00
Incremental Earnings Per Share ($70  $40)…………………..

$ 1.75
Because the $1.75 incremental EPS is less than the
$2.71 basic EPS, the convertible bonds are dilutive.
This means that when Diluted EPS is computed, the
total shares that would be issued on conversion will be
added to the denominator. It also means that the
interest expense (net of taxes) that was paid on the
bonds will be added to the numerator.
Net Income for Diluted EPS
19-13
Net income for basic EPS……………………………………… $810,000
Net Income for Diluted EPS
19-14
Net income for basic EPS……………………………………… $810,000
Add interest expense net of taxes on convertible bonds
($1,000,000 x .10 x .70)………………………………………
70,000
Net Income for Diluted EPS
19-15
Net income for basic EPS……………………………………… $810,000
Add interest expense net of taxes on convertible bonds
($1,000,000 x .10 x .70)………………………………………
70,000
Net income for diluted EPS……………………………………. $880,000
The “If Converted” Method
19-16

Since the options have an option price of $22.50 and
the average price for Carrizo’s stock during the year
was $36, the options are dilutive.
The “If Converted” Method
19-17


Since the options have an option price of $22.50 and
the average price for Carrizo’s stock during the year
was $36, the options are dilutive.
However, even though the options are for 30,000
shares of common stock, the incremental shares of
common stock issued by Carrizo will be less than this
number.
The “If Converted” Method
19-18



Since the options have an option price of $22.50 and
the average price for Carrizo’s stock during the year
was $36, the options are dilutive.
However, even though the options are for 30,000
shares of common stock, the incremental shares of
common stock issued by Carrizo will be less than this
number.
To find the incremental shares to be issued that would
be issued if the options were exercised, we assume
Carrizo will use the proceeds from the options to
repurchase as many shares as possible at the
average market price.
The “If Converted” Method
19-19
Shares assumed issued on exercise of options………………
30,000
The “If Converted” Method
19-20
Shares assumed issued on exercise of options………………
30,000
Less: Shares assumed repurchased from proceeds of
options (30,000 x $22.50 = $675,000; $675,000  $36
average price)…………………………………………………
18,750
The “If Converted” Method
19-21
Shares assumed issued on exercise of options………………
30,000
Less: Shares assumed repurchased from proceeds of
options (30,000 x $22.50 = $675,000; $675,000  $36
average price)…………………………………………………
18,750
Incremental shares assumed issued on exercise of options ..
11,250
Computation of Diluted EPS
19-22
Weighted-average shares outstanding for
basic EPS………………………………………………
298,667
Incremental shares:
Shares assumed to be issued on
conversion of bonds………………………………
40,000
Computation of Diluted EPS
19-23
Weighted-average shares outstanding for
basic EPS………………………………………………
298,667
Incremental shares:
Shares assumed to be issued on
conversion of bonds………………………………
On assumed exercise of options………………….
40,000
30,000
Less: Shares assumed repurchased from
proceeds of options………………………………. 18,750
Shares assumed outstanding for diluted EPS……….
11,250
349,917
Computation of Diluted EPS
19-24
Weighted-average shares outstanding for
basic EPS………………………………………………
298,667
Incremental shares:
Shares assumed to be issued on
conversion of bonds………………………………
On assumed exercise of options………………….
40,000
30,000
Less: Shares assumed repurchased from
proceeds of options………………………………. 18,750
Shares assumed outstanding for diluted EPS……….
11,250
349,917
Net income for diluted EPS …………………………………
$880,000
Shares assumed outstanding for diluted EPS ……………
 349,917
Diluted Earnings Per Share ($880,000  $349,917)………
$ 2.51
19-25
End of Problem