Isco’s financial statements show a profit for the year to 31 December 20X5 of $2 million. On 1 January 20X5 Isco had 4 million shares in issue and made no further issues of shares during the year. At 31 December 20X5 there were 1 million outstanding options to buy shares at $3 each. For the year to 31 December 20X5, the average market value of Isco’s shares was $5. What is Isco’s diluted earnings per share for the year ended 31 December 20X5? A 50.0¢ B 28.6¢ C 45.5¢ D 43.4¢
Question
Isco’s financial statements show a profit for the year to 31 December 20X5 of 3 each. For the year to 31 December 20X5, the average market value of Isco’s shares was $5. What is Isco’s diluted earnings per share for the year ended 31 December 20X5? A 50.0¢ B 28.6¢ C 45.5¢ D 43.4¢
Solution
To calculate the diluted earnings per share (EPS), we first need to understand what it means. Diluted EPS takes into account what would happen if all convertible securities were exercised. In this case, the convertible securities are the outstanding options to buy shares.
Here are the steps to calculate the diluted EPS:
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Calculate the number of new shares that could be created if the options were exercised. This is done by dividing the total amount that would be received from exercising the options (3 each) by the average market value of the shares ($5). This gives us 600,000 new shares.
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Add this number of new shares to the current number of shares in issue to get the total diluted number of shares. This is 4 million (current shares) + 600,000 (new shares) = 4.6 million shares.
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Divide the profit for the year by the total diluted number of shares to get the diluted EPS. This is $2 million / 4.6 million shares = 43.48¢ per share.
So, the closest answer to the question is D, 43.4¢.
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