CFA Level IFinancial Statement AnalysisEasy
A company reports net income of $1,200,000 for the year and pays $200,000 in preferred dividends. The weighted average number of common shares outstanding during the year is 500,000, and the company has no dilutive securities outstanding. What is basic earnings per share (EPS)?
- A$2.00
- B$2.50
- C$1.80
- D$2.40
Show answer & explanationAnswer & explanation
Correct answer: A. $2.00
Basic EPS = (Net income − Preferred dividends) / Weighted average common shares = ($1,200,000 − $200,000) / 500,000 = $1,000,000 / 500,000 = $2.00. Preferred dividends must be subtracted because they are not available to common shareholders.
Why the other options are wrong
- B. Uses an incorrect (too low) share count of 400,000 instead of 500,000.
- C. Results from an incorrect double subtraction of preferred dividends.
- D. Incorrectly uses net income without subtracting preferred dividends ($1,200,000/500,000).
Basic Earnings Per Share (EPS)
Basic EPS measures the amount of income attributable to each common share, calculated by subtracting preferred dividends from net income and dividing by the weighted average number of common shares outstanding.
- Formula: (Net income − Preferred dividends) / Weighted average common shares
- Preferred dividends are always subtracted, even if not declared, for cumulative preferred stock
- Basic EPS does not consider convertible securities or options (that's diluted EPS)
Memory trick: Subtract preferred, divide by shares — that's basic EPS care.