Howat Corporation earned $360,000 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 $15 per share during the period. Also outstanding were 15,000 warrants that could be exercised to purchase one share of common stock for $10 for each warrant exercised.

(a) Are the warrants dilutive?

(b) Compute basic earnings per share. (Round answer to 2 decimal places, e. g. $2.55.)

(c) Compute diluted earnings per share.

The answer is:

A. Yes

B. 3.6

C. 3.43

Explanation:

A. Yes, the warrants is dilutive because the average market price ($15) is higher than option price ($10).

B. Since there is no preferred shares or preferred dividends, the basic earnings per share is:

Net income : weighted average shares

= $360,000 : 100,000 shares

= 3.6

C. First we need to find the incremental shares. The formula is:

[ (average market price - option price) : average market price]x number of shares

[ ($15 - $10) : $15] x 15,000 shares

$0.33333 * 15,000 shares

5,000 shares

Total number of shares is now 105,000shares (100,000 shares + 5,000)

Therefore, diluted shares is now

$360,000 : 105,000 shares

3.43