Computing Earnings per Share: Stock Options

Falcon Company has a compensatory stock option plan under which options to buy 459,000 common shares were issued in Year 1. These options are exercisable during Year 2 and Year 3 at $29 per share.

In Year 2, Falcon reported net income of $900,000; the companys capital structure remained unchanged that year. Outstanding stock consists of 1,800,000 common shares, which traded at an average price of $36 per share throughout Year 2.

The companys long-term debt consists of a $2,500,000 bond issue sold at par, which pays 12% annual interest and was outstanding throughout Year 2. Falcon had no other debt. Falcons income tax rate is 25%.

Required

a. Compute basic and diluted EPS for Year 2.

b. Assume instead that Falcon issued the stock options on July 1 of Year 2 and that the market price of its stock averaged $40 per share throughout the last half of Year 2. Compute basic and diluted EPS for Year 2.