Cullumber Corporation earned $355,000 during a period when it had an average of 100,000 shares of common stock outstanding. The common stock sold at an average market price of $21 per share during the period. Also outstanding were 14,700 warrants that could be exercised to purchase one share of common stock for $14 for each warrant exercised. (a) Are the warrants dilutive? (b) Compute basic earnings per share. (c) Compute diluted earnings per share.

(a) Yes. The warrants are dilutive.

(b) Basic EPS = $3.55 / Share

(c) Diluted EPS = $3.384 / Share

Explanation:

(a) The warrants can be categorized as potential ordinary shares as they can be converted into ordinary shares if exercised. Such conversion of warrants into ordinary shares can increase the number of ordinary shares in future and dilute the future earnings of shareholders. Thus, the warrants are dilutive.

(b) Basic earning per share is calculated using the following formula,

Basic EPS = Earnings or Net Income / Number of Ordinary Shares Outstanding Basic EPS = $355000 / 100000 = $3.55 / Share

(c) For diluted EPS, we need to take into account the number of shares that are dilutive and separate the bonus share amount and the number of shares for which we are receiving payment in full. This is done whenever the options/warrants only pay a part of the market price of the shares-in this case, only 14/share will be received if converted instead of 21.

Bonus element = Total Shares - Shares fully paid for Bonus element = 14700 - [ (14700*14) / 21] = 4900 Shares Diluted EPS = 355000 / (100000 + 4900) = $3.384175 / Share