Lecture 15 - Eanrnings Per Share

Question 1

What is the P/E ratio? And what does it essentially calculate?

Answer 1

The P/E ratio is the ratio of the price per share over the earnings per share (EPS).

It can therefore be interpreted as the number of years of earnings required to recoup the price paid for a share.

Question 2

A higher P/E ratio =

Answer 2

High growth prospects

Question 3

What 4 factors influence the P/E ratio?

Answer 3

1. Current performance
2. The state of the national economy and individual sector
3. International developments
4. Potential/possible changes in senior management

Question 4

IAS 33 defines two EPS figures to be disclosed, what are they?

Answer 4

Basic EPS - based on ordinary shares currently in issue.

Diluted EPS - based on ordinary shares currently in issue+potential ordinary shares

Question 5

What is the calculation for basic EPS?

Answer 5

“Net profit/loss attributable to ordinary shareholders divided by the weighted number of ordinary shares”

Question 6

In the basic EPS calculation, net profit means…

Answer 6

The consolidated profit/loss for the period after deciding preference dividends.

Question 7

Give three limitation of using EPS as a measure of performance.

Answer 7

1. EPS is based on historical earnings
2. EPS doesn’t take into account inflation
3. EPS is affected by managements choice of accounting policies
4. EPS is affect by the capital structure of a firm

Question 8

What are bonus issues?

Answer 8

Bonus shares are shares issued to shareholders of a company free of any cost. They’re an alternative to cash dividends and therefore may be issued when the company has proof cash flow and don’t want to upset shareholders.

Question 9

Bonus issues can also be known as…

Answer 9

Script or scrip issues

Question 10

The allocation of bonus issues leads to more … in the capital.

Answer 10

Shares and therefore more (share capital).

Question 11

A bonus issue provides a financial benefit to whom?

Answer 11

Neither the company or the shareholder

Question 12

What is a share/stock split?

Answer 12

A share/stock split is a corporate action in which a company divides its existing shares into multiple shares in order to boost the liquidity of the shares.

Question 13

What are the two main resulting effects of a stock split?

Answer 13

1. The number of shares increase

2. The total dollar value of the shares remains the same

Question 14

Why would a firm with a high prices share choose to split a share?

Answer 14

To boost liquidity

Question 15

What is the accounting treatment for a stock split that occurs part way through the year?

Answer 15

The split is treated as if it happened at the start of the year.

Question 16

What is the accounting treatment of new shares issues at full market price during the year?

Answer 16

The number of shares available throughout the year needs to be weighted. For example, if a firm had 500 shares available for 9 months of the year and 750 avaliable for the remaining 3 months, we would have to calculate 500 x 9/12 + 750 x 3/12.

Question 17

What is a buyback?

Answer 17

A buyback is when a company buys its own outstanding shares to reduce the number of shares available on the open market.

Question 18

A buyback can also be known as…

Answer 18

A share repurchase

Question 19

What are the 4 main reasons a firm would choose to buyback their outstanding shares?

Answer 19

1. To reduce the cost of capital when equity costs more than debt.
2. When shares are undervalued.
3. To return surplus cash to the shareholders.
4. To increase the apparent rate of growth in BEPS.

Question 20

What is the accounting treatment for BEPS when a firm chas conducted a buyback?

Answer 20

The weighted average of the number of outstanding shares needs to be calculated and then divided by the profit for the year.

Question 21

What is meant by the term ‘diluted EPS’?

Answer 21

Diluted EPS is a calculation used to gauge the quality of a company’s earnings per share if all convertible securities were exercised.

Question 22

What is the ‘relationship’ between basic EPS and Diluted EPS?

Answer 22

Diluted EPS will always be lower than basic EPS

Question 23

What’s the reason as to why the term ‘diluted’ is used in the Diluted EPS term?

Answer 23

Dilute because earnings in the future may be spread over a larger number of shares.

Question 24

Give some examples of securities that may have a dilutive effect on future earnings.

Answer 24

• convertible securities
• deferred equity
• employee share options
• share warrants
• potential ordinary shares

Question 25

In the Diluted EPS only considers…

Answer 25

The dilutive potential shares, not the other outstanding shares.

Question 26

What is meant by the term ‘convertible security’? And what are the most common forms of it?

Answer 26

A convertible security is an investment that can be changed into another form. The most common forms of convertible securities are convertible bonds and convertible preferred stock, which can be converted to common stock.

Question 27

Why do firms issue securities with conversion rights?

Answer 27

Often companies attach conversion rights to loan stock to secure a lower rate of interest on their borrowings.

Question 28

When stock options are ultimately converted, it should have two impacts on the firms financial position…

Answer 28

1. Post-tax profits should be adjusted to reflect the increase in earnings due to the lower amount of interest being paid after conversion.
2. An increase in the number of shares now being paid dividends should increase

Question 29

When calculating the diluted EPS, the preference dividend paid in the year should be…

Answer 29

Added back.

Question 30

Under IAS 33, what EPS figures must be disclosed on the finials statements?

Answer 30

Both BEPS and DEPS