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Treasury Stock - Transactions Affecting Shareholders’ Equity
Basic EPS is computed by dividing income available to the common stockholders by the average number of shares outstanding:
EPS = Net income available for common shareholders / Average number of common shares outstanding
For example, Starbright Company reported net income of $99 million in 2001 and had 45 million shares of common stock outstanding throughout the entire year. Starbright’s 2001 EPS is $2.20, calculated as follows:
EPS = $99 million / 45 million shares
EPS = $2.20
Basic EPS Calculations with Changes in Shares Outstanding
It is unusual fora large firm’s outstanding shares to remain constant throughout the year. Additional stock transactions cause the number of shares to vary over the year. In these cases, the denominator in the EPS calculation is the weighted average of the common shares outstanding during the year. To illustrate, assume that Starbright reported net income of $118 million during 2001 and that the firm’s common shares changed as shown in figure 9.4.
Figure 9.4 Common Shares Outstanding
To calculate Starbright’s EPS for 2001, we need first to determine the firm’s weighted average shares outstanding during the year. The calculation appears in Figure 9.5 and shows that each level of outstanding shares is weighted by the fraction of the year that it stayed constant.
Figure 9.5 Weighted Average Common Shares
Figure 9.5 shows that Starbright’s average shares outstanding in 2001 was 54 million. Accordingly, the firm’s EPS in 2001 was
EPS = Net income, $118 million / Weighted average shares, 54 million
EPS = $2.19 per share
Basic EPS Calculations with Preferred Stock Outstanding
When a firm has both preferred and common stock outstanding, the preferred stock’s share of net income must be subtracted in order to determine the basic EPS of the common stock. This is required because dividends must be paid to preferred shareholders before any earnings are available to common shareholders. Cumulative preferred stock always must be allocated its portion of net income. Noncumulative preferred stock is assigned a portion of income only in years when the firm actually declares a preferred stock dividend.
To illustrate, assume that Avalon Company reports net income of $120 million in 2001 and has both preferred and common stock outstanding. Pertinent details about the stock issues appear in Figure 9.6.
Figure 9.6 - Stock Issue Details
Types of Earnings Per Share
Related Shareholders' Equity Topics
Transactions Affecting Shareholders’ Equity
Analysis Based on Shareholders' Equity
