Questions and Answers
What is the degree of financial leverage?
What is the purpose of disclosing per-share amounts in corporate income statements?
What is the formula for basic earnings per share?
Why is the weighted average number of common shares outstanding used in the calculation of basic EPS?
Signup and view all the answers
What type of shares are pertained to in the calculation of basic EPS?
Signup and view all the answers
What is the purpose of disclosing earnings per share?
Signup and view all the answers
What is included in the calculation of basic EPS?
Signup and view all the answers
What is the relationship between the degree of financial leverage and the percentage change in net income?
Signup and view all the answers
Why is the weighted average number of common shares outstanding used in the calculation of EPS?
Signup and view all the answers
What is the purpose of disclosing per-share amounts for discontinued operations and extraordinary items?
Signup and view all the answers
Study Notes
Weighted Average Common Outstanding Shares
- Calculate weighted average common outstanding shares by multiplying shares outstanding by the fraction of the year outstanding.
- Example: 10,000 shares outstanding from January to June, multiplied by 6/12, equals 5,000 weighted average shares.
Earnings Per Share and Capital Structure
- A simple capital structure refers to basic earnings per share.
- A complex capital structure contains potentially dilutive securities, such as:
- Options
- Rights
- Warrants
- Convertible debt
- Convertible preferred equity
- Contingent shares
Price/Earnings Ratio
- Calculate price/earnings ratio by dividing market price per share by diluted earnings per share before nonrecurring items.
- The ratio measures the relationship between market price and current earnings per share.
- Using diluted earnings per share gives a more conservative price/earnings ratio.
Interpreting Price/Earnings Ratio
- Compare price/earnings ratio with:
- Industry competitors
- Industry average
- Exchange (e.g., NYSE) average
- Interpretation:
- High-growth-potential firms have higher P/E ratios
- P/E ratio is a function of the market
Percentage of Earnings Retained
- Calculate percentage of earnings retained by dividing net income before nonrecurring items minus all dividends by net income before nonrecurring items.
- This ratio reflects the proportion of current earnings retained for internal growth.
- Trend analysis is improved by excluding nonrecurring items.
- Higher percentage typically found in:
- New firms
- Growing firms and firms perceived as growth firms
Dividend Payout
- Calculate dividend payout by dividing dividends per common share by diluted EPS before nonrecurring items.
- This ratio measures the portion of current earnings per common share being paid out in dividends.
- A stable dividend policy is developed by considering recurring earnings.
- Lower payout typically found in:
- New firms
- Growing firms and firms perceived as growth firms
Dividend Yield
- Calculate dividend yield by dividing dividends per common share by market price per common share.
- This ratio indicates the relationship between dividends per common share and market price per common share.
- The yield is a function of:
- The firm’s dividend policy
- Market price
Degree of Financial Leverage
- The degree of financial leverage is the multiplication factor by which net income changes in respect to changes in EBIT.
- A more simple formula for degree of financial leverage is:
- % Change Net Income / % Change EBIT
Earnings Per Share
- Earnings per share is required disclosure for corporate income statements.
- Earnings per share pertains only to common stock.
- Per-share amounts are disclosed for:
- Income from recurring items
- Discontinued operations
- Extraordinary items
- Net income
Basic Earnings Per Share
- Calculate basic earnings per share by dividing net income minus preferred dividends by weighted average number of common shares outstanding.
- Earnings pertain to an entire fiscal period.
- Average common shares outstanding is used for parity of information.
Studying That Suits You
Use AI to generate personalized quizzes and flashcards to suit your learning preferences.
Description
This quiz is about calculating the weighted average of outstanding shares over a period of time, with changes in the number of shares during different months.
