(Case introducing earnings per share calculations for companies with a complicated capital structure.) The Layton Ball Corporation has a relatively complicated capital structure. In addition to common shares, it has issued stock options, warrants, and convertible bonds. Exhibit 11.4 summarizes some pertinent information about these items. Net income for the year 1979 is \(\$ 9,500\), and the income tax rate used in computing income tax expense is 40 percent of pretax income.

a First, ignore all items of capital except for the common shares. Calculate earnings per common share.
b In past years, employees have been issued options to purchase shares of stock. Exhibit 11.4 indicates that the price of the common stock throughout 1979 was \(\$ 25\), but that the stock options could be exercised at any time for \(\$ 15\) each. The holder of an option

is allowed to surrender it along with \(\$ 15\) cash and receive one share in return. Thus the number of shares would be increased, which would decrease the earnings-per-share figure. The company would, however, have more cash. We could assume that the company would use the cash to go out and buy outstanding shares for the treasury, which would reduce the number of shares outstanding and increase earnings per share. Assume that the holders of warrants were to tender their warrants along with \(\$ 15\) each to purchase shares. Assume that the company would use the cash to purchase shares for the treasury at a price of \(\$ 25\) each. Compute a new earnings-per-share figure. (Treasury shares are not counted in the denominator of the earnings-per-share calculation.)
c Exhibit 11.4 indicates that there are also warrants outstanding in the hands of the public. Anyone who owns such a warrant is allowed to turn in that warrant along with \(\$ 30\) cash and to purchase one share. If the warrants are exercised then there would be more shares outstanding, which would reduce earnings per share. The company would, however, have more cash, which it could use to purchase shares for the treasury, reducing the number of shares outstanding. Assume that all holders of warrants were to exercise them. Assume that the company were to use the cash to purchase outstanding shares for the treasury. Compute a new earnings-per-share figure. (Ignore the information about options and the calculations in part \(\mathbf{b}\) at this point.)
d There are convertible bonds outstanding. A holder of a convertible bond is entitled to trade that bond in for 10 shares. If a bond is converted, the number of shares would increase, which would tend to reduce earnings per share. On the other hand, the company would not have to pay interest and thus would have no interest expense on the bond because it would no longer be outstanding. This would tend to increase income and earnings per share. Assume that all holders of convertible bonds were to convert their bonds into shares. Compute a new net income figure (do not forget income tax effects on income of the interest saved) and a new earnings per share figure. (Ignore the information about options and warrants and the calculations in parts \(\mathbf{b}\) and \(\mathbf{c}\) at this point.)
e Now consider all the above calculations. Which sets of assumptions from parts \(\mathbf{b}\), \(\mathbf{c}\), and \(\mathbf{d}\) would lead to the lowest possible earnings per share when they are all made simultaneously? Compute a new earnings per share under the most restrictive set of assumptions about reductions in earnings per share.
f Accountants publish several earnings-per-share figures for companies with complicated capital structures and complicated events during the year. The Wall Street Journal, however, publishes only one figure in its daily columns (where it reports the priceearnings ratio - the price of a share of stock divided by its earnings per share). Which of the figures computed above for earnings per share do you think would be reported by The Wall Street Journal as the earnings-per-share figure?

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EXHIBIT 11.4 Layton Ball Corporation Information on Capital Structure for Earnings-per-Share Calculation (Problem 37) Assume the following data about the capital structure and earnings for the Layton Ball Corporation for the year 1979: Number of Common Shares Outstanding Throughout 1979 Market Price per Common Share Throughout 1979. Options Outstanding During 1979: Number of Shares Issuable on Exercise of Options Exercise Warrants Price per Share. Warrants Outstanding During 1979: Number of Shares Issuable on Exercise of Warrants Exercise Price per Share Convertible Bonds Outstanding (Issued in December 1968) Number... Proceeds per Bond at Time of Issue (= par value) Shares of Common Issuable on Conversion (per bond) Coupon Rate (per year).. 2,500 shares $25 1,000 shares $15 2,000 shares $30 100 bonds. $1,000 10 shares 41%