Homework SourseA ClassCo sells Convertible Bond with warrant to convert int
| A. | ClassCo sells Convertible Bond with warrant to convert into stock | ||||||
| Bond with face | $1,000 | ||||||
| Face Rate | 8.00% | ||||||
| Term | 3 | Yrs. | |||||
| Market rate @ sale | 8.50% | ||||||
| issued: | 30/06/18 | ||||||
| maturity | 30/06/21 | ||||||
| Interest paid annually | |||||||
| Bond sold for | 996.00 | ||||||
| 1. determine value received from sale, Discount or Premium? | |||||||
| 2. Prepare JE to record sale, use incremental | |||||||
| assume value of Bond in the known | |||||||
| and value of warrant is incremental | |||||||
| B. | ClassCo: | PE 12/31/2018 | Fiscal = calendar Yr. | ||||
| Net income: after tax | 2000 | shares: | |||||
| Beginning: | 505 | ||||||
| 3/1 issue | 50 | ||||||
| 9/1 issue | 60 | ||||||
| Treasury Purchase 10/30 | (24) | ||||||
| on 11/22, 3 for 1 split | |||||||
| Preferred dividends this year = | 250 | ||||||
| 1. Calculate EPS | |||||||
| 2. using \"as if\" compute EPS & dilutive effect of Convertible Bonds | |||||||
| issued 10 bonds , $1000 bonds issued prior yr., 6%, each bond was convertible into 30 shares | |||||||
| 40% tax rate for bonds | |||||||
| C. | NET Income: | 4500 | No preferred stock | ||||
| Average # of Shares | 2200 | EPS = | 2.045 | ||||
| Stock Options: | all full Yr. | ||||||
| # option shares | 500 | ||||||
| 0ption price per share | $18 | ||||||
| Market at PE being measured | $32 | ||||||
| Compute dilutive effect per share |
| A. | ClassCo sells Convertible Bond with warrant to convert into stock | ||||||
| Bond with face | $1,000 | ||||||
| Face Rate | 8.00% | ||||||
| Term | 3 | Yrs. | |||||
| Market rate @ sale | 8.50% | ||||||
| issued: | 30/06/18 | ||||||
| maturity | 30/06/21 | ||||||
| Interest paid annually | |||||||
| Bond sold for | 996.00 | ||||||
| 1. determine value received from sale, Discount or Premium? | |||||||
| 2. Prepare JE to record sale, use incremental | |||||||
| assume value of Bond in the known | |||||||
| and value of warrant is incremental | |||||||
| B. | ClassCo: | PE 12/31/2018 | Fiscal = calendar Yr. | ||||
| Net income: after tax | 2000 | shares: | |||||
| Beginning: | 505 | ||||||
| 3/1 issue | 50 | ||||||
| 9/1 issue | 60 | ||||||
| Treasury Purchase 10/30 | (24) | ||||||
| on 11/22, 3 for 1 split | |||||||
| Preferred dividends this year = | 250 | ||||||
| 1. Calculate EPS | |||||||
| 2. using \"as if\" compute EPS & dilutive effect of Convertible Bonds | |||||||
| issued 10 bonds , $1000 bonds issued prior yr., 6%, each bond was convertible into 30 shares | |||||||
| 40% tax rate for bonds | |||||||
| C. | NET Income: | 4500 | No preferred stock | ||||
| Average # of Shares | 2200 | EPS = | 2.045 | ||||
| Stock Options: | all full Yr. | ||||||
| # option shares | 500 | ||||||
| 0ption price per share | $18 | ||||||
| Market at PE being measured | $32 | ||||||
| Compute dilutive effect per share |
Solution
Greetings,
A) The market price of the bond should be less than 1000 because face rate is 8% whereas market rate is 8.5%. We can easily calculate market price using excel formula -
=PV(rate,time,pmt,fv,0)
Where rate =0.085
Time = 3
Put = coupon amount ie 8% of 1000 = 80
FV = 1000
Putting the inputs in above formula, we get PV = 987
But the bond is sold for 996, so there is premium charged $9. It will be due to warrant attached ie conversion option. Otherwise the bond is sold at a discount of $13
Journal Entry -
Bank A/c ......Dr 996
Discount on sale ......Dr 13
To Bond at FV 1000
To Warrant 9
(Being convertible bind issued at a discount of $13 but with added $9 for conversion feature)
Note - Journal Entry nay vary a bit from country to country depending upon the GAAP applicable.
B) Calculation of EPS -
Earnings available for equity shareholders = PAT - Preferred Dividend = 2000-250=1750
Weighted average outstanding shares -
Beg shares = 505
Add Issued on 3/1 (outstanding for 10 months) = 50*10/12 = 41.67
Add Issued on 9/1 (outstanding for 4 months) = 60*4/12 = 20
Less Bought Back on 10/30 (outstanding for 2 months)=24*2/12 =4
Total on 30/10 = 562.67
Add - stock split (2 extra shares for every share held) =562.67*2 = 1125.33
Total shares o/s on 12/31 = 1688*
Therefore EPS = 1750/1688 = 1.0367
* for share split or reverse share split or stock bonus, we do not do time weighted average as this are just accounting gimmicks and do not involve any cash flows.
Calculation of diluted EPS -
Interest of the binds will be added back net of taxes = 1000*10*6%*(1-0.4) = 360
No. of shares which can be converted = 10*30 = 300
Incremental EPS = 360/300=1.2 . Since it is greater than EPS prior to considering effects of potentially dilutive instruments ie convertible bonds, hence dilutive EPS = Basic EPS =1.0367
Proof - Dilutive EPS = (1750+360)/(1688+300) = 1.061.
Since dilutive EPS can\'t be more than basic EPS, hence both are equal.
Note - Convertible bonds were issued in the previous years hence entire 300 shares are potentially dilutive during the year.
C) Potentially dilutive shares as a result of options are calculated as under = (no of options *option price)/market price of the share
= (500*18)/32 = 281.25 shares
Since option have no service costs , hence nothing is to added to the numerator. So options are dilutive always. Further there were dilutive during whole 12 months, henec no need to apply time step *12/12 = 1 * 281.25 = 281.25
Dilutive EPS = (4500)/(2200+281.25) = 1.8136 per share
