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Q5. (RTP Nov. 22)

Company S is a subsidiary of Company P. Following facts are in respect of Company S:
 Company S has 10,000 ordinary shares and 1,000 options outstanding, of which Company P owns 9,000

shares and 500 options, respectively.
 The options have an exercise price of Rs. 40.
 The average market price of Company S’s ordinary share was Rs. 50 in 20X1.
 In 20X1, Company S’s profit was Rs. 30,000.

Following facts are in respect of Company P:
 Company P has 5,000 ordinary shares outstanding.
 In 20X1, Company P’s profit (excluding any distributed and undistributed earnings of subsidiaries) was Rs.
7,000.
 The options outstanding are dilutive at P’s level.

Determine the diluted EPS of Company P for the year 20X1. Ignore income tax.
SOLUTION

To determine the diluted EPS of Company P, the diluted EPS of Company S has to be calculated first.

Calculation of Company S’s diluted EPS:
Company S’s earnings for the period Rs. 30,000
Weighted average ordinary shares 10,000

Incremental shares (refer W.N.) 200
Company S’s diluted EPS Rs. 30,000/ (10,000 + 200)
Rs. 2.94
Calculation of Company P’s diluted EPS:

Company P’s earning for the period Rs. 7,000
Company P’s share of Company S’s earning Rs. 26,460
attributable to ordinary shares [(9,000 /10,000) x (2.94 x 10,000)]

Company P’s share of Company S’s earning attributable to options Rs. 294
[(500 /1,000) x (2.94 x 200)]
Company P’s weighted average ordinary shares outstanding 5,000
Company P’s diluted EPS = (7,000 + 26,460 + 294) / 5,000 Rs. 6.75

Working Note:

Computation of Incremental shares related to weighted average options outstanding:
All options are dilutive because their exercise price is below the average market price of Company S’s
ordinary shares for the period.

The incremental shares are calculated as follows:
Shares issued on assumed exercise of options 1,000
Less: Shares that would be issued at average market Price [(40 x 1,000)/50] (800)
Incremental shares 200

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