4.2 Earnings per Share.

Firm A reports an increase in earnings per share; Firm B reports a

decrease in earnings per share. Is this unconditionally informative about each firm’s
performance? If not, why is earnings per share so commonly discussed in the financial
press?

Earnings per share commonly known as EPS, it divides the firms earning by its total number of
outstanding equity share in the market, even if two firms are completely identical in all aspects
they can report two different types of EPS since the difference of this amount will only because
of management decision regarding the total number of outstanding share in the market. Since
EPS is highly depended on outstanding share it cannot be used as the right tool to compare two
firms performance.

Press conference always hike the news about EPS since it is compared to price per share and
used to calculate the price-earnings ratio which in a way helps the investors to make a estimate
value of the firms earning pattern.

4.7 The intuition behind the benefits of financial leverage is that a firm can borrow funds
that bear a certain interest rate but invest those funds in assets that generate returns in
excess of that rate. Why would firms with high ROAs not keep leveraging up their firm by
borrowing and investing the funds in profitable assets?

Financial leverage helps the management to run the operations smoothly and have a quick
movement of cash by procuring and selling the goods, there may be time that inventor is not sold
within due time or may take unnecessary long time to liquidate due to unexpected market reason
under these circumstances high leverage will be an unjust cost burden for the firm.

4.12 TJX, Inc., an apparel retailer, reported net income (amounts in thousands) of $609,699
for Year 4. The weighted average of common shares outstanding during Year 4 was
488,809 shares. TJX, Inc., subtracted interest expense net of tax saving on convertible debt
of $4,482. If the convertible debt had been converted into common stock, it would have
increased the weighted-average common shares outstanding by 16,905 shares. TJX, Inc.,
has outstanding stock options that, if exercised, would increase the weighted average of
common shares outstanding by 6,935 shares. Compute basic and diluted earnings per share
for Year 4, showing supporting computations.

Calculate Basic EPS.

Given information:

Net income = $609,699

Outstanding shares = 488,809

Thus, Basic EPS is $1.25 per share.

Calculate Diluted EPS.

Given information:

Net income = $609,699

Interest expenses = $4,482

Outstanding shares = 488,809

Convertible debentures = 16,905

Convertible options = 6,935

Thus, Diluted EPS is $1.20 per share.

4.13 Boston Scientific, a medical device manufacturer, reported net income (amounts in
millions) of $1,062 on sales of $5,624 during Year 4. Interest expense totaled $64. The
income tax rate was 35%. Average total assets were $6,934.5, and average common
shareholders’ equity was $3,443.5. The firm did not have preferred stock outstanding or
noncontrolling interest in its equity.

a. Compute the rate of ROA. Disaggregate ROA into profit margin for ROA and assets turnover
components.

b. Compute the rate of ROCE. Disaggregate ROCE into profit margin for ROCE, assets turnover,
and capital structure leverage ratio components.

c. Calculate the amount of net income to common shareholders derived from the excess return on
creditors’ capital and the amount from the return on common shareholders’ capital.

Company BS has stated information about the company for Year 4. The net income for
Company BS was $1,062 and sales were $5,624. The interest expenses were $64. The
income tax rate was 35% and average total assets were $6,934.5 and the common
shareholders’ equity was $3,443.5.

(a)

Calculate Return on Assets (ROA) using profit margin and assets turnover as follows:

Step 1: Calculate Profit margin follows:

Step 2: Calculate Assets Turnover as follows:

Step 3: Calculate Return on Assets (ROA) using profit margin and assets turnover as
follows:
Therefore, the ROA is 15.31% .

(b)

Calculate Return on Common Equity (ROCE) using profit margin; assets turnover and
capital structure leverage ratio components as follows:

Step 1: Calculate Profit margin follows:

Step 2: Calculate Assets Turnover as follows:

Step 3: Calculate the capital structure leverage ratio as follows:

Step 4: Calculate Return on Common Equity (ROCE) using profit margin; assets turnover
and capital structure leverage ratio components as follows:

Therefore, the ROCE is 30.84 %.

(c)

Here, excess return on creditors’ capital is the Earnings before interest and taxes.

Step 1: Calculate the Earnings before interest and taxes (EBIT) from the net income as
follows:

Particulars Calculation Amount

EBIT $1,697.85

Less: Interest Given $64.00

EBT (Earnings before tax) $1,633.85

Less: Tax at 35% $571.85

Net income Given $1,062.00

Step 2: Calculate the net income from the EBIT as follows:

Particulars Amount
EBIT $1,697.85
Less: Interest $64.00
EBT (Earnings before tax) $1,633.85
Less: Tax at 35% $571.85
Net income $1,062.00