The current assignment aims to deal with the specific case of Performance Apparel Inc (PA), which is a retailer of sports footwear and apparel. The main retail stores of the organization are located in Beaverton, Oregon; however, it has branches throughout the nation. For motivating particular members of the senior management, it has decided to issue performance-based restricted units of stock (RSUs) on 1st January 2014. However, the organization does not have any prior experience about the issuance of this type of award and the way of accounting for this issuance in their diluted earnings per share (EPS). Therefore, the current assignment aims to compute three-year average organic growth rate, which PA needs to assume in order to compute the diluted EPS.
The average annual growth rate is the average rise in the value of investment, asset, portfolio or cash stream over specific time interval. This is computed by taking into account the arithmetic mean of growth rate over timeframes (Abraham, Marsden & Poskitt, 2015). According to the provided case study, PA is going to issue RSUs, which is a form of compensation as company stock. Hence, in order to calculate the diluted earnings per share, the income statement for the organization has been prepared in order to determine the organic growth rate for three years (Lashgari, 2016). This is briefly represented as follows:
|
Particulars |
Year 1 (in $) |
Year 2 (in $) |
Year 3 (in $) |
Year 4 (in $) |
|
Revenue |
150,000 |
180,000 |
225,000 |
281,250 |
|
Cost of sales |
65,000 |
71,500 |
78,650 |
86,515 |
|
Gross profit |
85,000 |
108,500 |
146,350 |
194,735 |
|
Operating expenses: |
||||
|
Advertising |
2,000 |
3,500 |
3,000 |
3,000 |
|
Depreciation |
4,000 |
4,000 |
4,000 |
4,000 |
|
Wages and salaries |
25,000 |
25,000 |
25,000 |
40,000 |
|
Utilities |
3,000 |
3,000 |
3,000 |
3,000 |
|
Supplies |
4,000 |
4,500 |
5,200 |
6,000 |
|
Rent |
3,000 |
3,000 |
3,000 |
3,000 |
|
Total operating expenses |
41,000 |
43,000 |
43,200 |
59,000 |
|
Operating income |
44,000 |
65,500 |
103,150 |
135,735 |
|
Interest expense |
6,000 |
7,500 |
9,200 |
15,000 |
|
Profit before tax |
38,000 |
58,000 |
93,950 |
120,735 |
|
Tax expense @30% |
11,400 |
17,400 |
28,185 |
36,221 |
|
Net income |
26,600 |
40,600 |
65,765 |
84,515 |
|
Preferred dividends @8% |
2,128 |
3,248 |
5,261 |
6,761 |
|
Retained earnings |
24,472 |
37,352 |
60,504 |
77,753 |
Table 1: Income statement of Performance Apparel Inc for four years
(Source: As created by author)
Based on the income statement, the three-year average organic growth rate that Performance Apparel Inc needs to assume has been computed and it has been represented in the form of a table as follows:
|
Years |
Net income (in $) |
|
1 |
26,600 |
|
2 |
40,600 |
|
3 |
65,765 |
|
4 |
84,515 |
|
Growth rate between years 1 and 2 |
52.63% |
|
Growth rate between years 2 and 3 |
61.98% |
|
Growth rate between years 3 and 4 |
28.51% |
|
Average organic growth rate |
47.71% |
Table 2: Three-year average organic growth of rate to be assumed by Performance Apparel Inc
(Source: As created by author)
The above table mainly helps in gauging the average rate of return of growth over a series of identically spaced timeframes (Bodie, 2013). However, as argued by Balaguer (2016), that the average organic growth rate is a linear measure and it fails to consider the impact of compounding. Hence, with the help of this average organic growth rate, PA could be able to ascertain the trends. According to the above table, the net incomes for the four years have been taken into consideration for determining the average rate of organic growth (Bruner et al., 2017). After computing the growth rate of the two years correspondingly, the average organic growth rate has been computed by averaging the growth rate of the three years. Based on that, the growth rate has been obtained as 47.71% over the three-year period. Accordingly, with the help of this rate, PA could compute diluted earnings per share.
As commented by Fisher, Shah & Titman (2016), diluted EPS considers the scenario when the exercise of dilutive securities are made. In case of Performance Apparel Inc, as the organization has not issued any type of wards like RSUs before, the computation of diluted EPS would help in providing an overview of the different scenarios. The awards are not common stocks; however, it could be converted into the same, if the holder exercises the option (Huang, Marquardt & Zhang, 2014). In case, the conversion is made, such awards would result in rise in number of outstanding shares. As a result, the earnings per share would decline, as the weighted number of shares is used in the computation of earnings per share (Kim & Yang, 2014). Hence, Performance Apparel Inc needs to take care of such scenario, as minimized earnings per share might result in loss of trust and confidence for the investors.
Conclusion:
From the above discussion, it has been evaluated that PA is going to issue RSUs, which is a form of compensation as company stock. Hence, in order to calculate the diluted earnings per share, the income statement for the organization has been prepared in order to determine the organic growth rate for three years. In case of Performance Apparel Inc, as the organization has not issued any type of wards like RSUs before, the computation of diluted EPS would help in providing an overview of the different scenarios. Finally, it has been found that if diluted awards are converted into common stock, it might result in minimized earnings per share and thus, it would decline the overall enterprise value.
References:
Abraham, M., Marsden, A., & Poskitt, R. (2015). Determinants of a firm’s decision to utilize a dividend reinvestment plan and shareholder participation rates: Australian evidence. Pacific-Basin Finance Journal, 31, 57-77.
Balaguer, J. (2016). Valuation and sensitivity analysis: California Resources Corporation.
Bodie, Z. (2013). Investments. McGraw-Hill.
Bruner, R. F., Bruner, R. F., Innes, M. J., Innes, M. J., Passer, W. J., Passer, W. J., … & Passer, W. J. (2017). American Telephone & Telegraph (AT&T): The AT&T/McCaw Merger Negotiation. Darden Business Publishing Cases, 1-39.
Fisher, G. S., Shah, R., & Titman, S. (2016). Analyst Long-Term Growth Forecasts, Accounting Fundamentals and Stock Returns.
Huang, R., Marquardt, C. A., & Zhang, B. (2014). Why do managers avoid EPS dilution? Evidence from debt–equity choice. Review of Accounting Studies, 19(2), 877-912.
Kim, D. S., & Yang, J. (2014). Beating the target: Performance management around the annual incentive target.
Lashgari, M. (2016). Profile of Common Stock a Global Perspective. Academy of Accounting and Financial Studies Journal, 20(2), 130.
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