BE4.8 (LO 3) In 2020, Hollis Corporation reported net income of $1,000,000. It declared and paid preferred stock dividends of $250,000. During 2020, Hollis had a weighted average of 190,000 common shares outstanding. Compute Hollis’s 2020 earnings per share
The correct answer and explanation is:
Earnings Per Share (EPS) Calculation: EPS=Net Income−Preferred DividendsWeighted Average Common Shares OutstandingEPS = \frac{{\text{Net Income} – \text{Preferred Dividends}}}{\text{Weighted Average Common Shares Outstanding}} EPS=1,000,000−250,000190,000EPS = \frac{{1,000,000 – 250,000}}{190,000} EPS=750,000190,000=3.95EPS = \frac{750,000}{190,000} = 3.95
Explanation (300 Words)
Earnings per share (EPS) is a key financial metric that represents the portion of a company’s profit allocated to each outstanding share of common stock. It is a crucial indicator of a company’s profitability and is widely used by investors to assess financial performance.
In this case, Hollis Corporation reported a net income of $1,000,000 in 2020. However, before calculating the EPS for common shareholders, we must account for preferred stock dividends, which amount to $250,000. Preferred stockholders have a higher claim on earnings than common shareholders, meaning these dividends must be subtracted from net income to determine the amount available to common shareholders.
After deducting the preferred dividends, the remaining income available for common shareholders is: 1,000,000−250,000=750,0001,000,000 – 250,000 = 750,000
Next, we divide this adjusted income by the weighted average number of common shares outstanding, which is 190,000 shares. This results in an EPS of $3.95.
EPS is an important figure because it helps investors evaluate a company’s profitability on a per-share basis. A higher EPS generally indicates that a company is more profitable and is generating more income per share, making it an attractive investment. However, EPS should be analyzed in conjunction with other financial metrics such as price-to-earnings (P/E) ratio, revenue growth, and cash flow to get a comprehensive understanding of a company’s financial health.
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