Problem 16 - Accounting Principles

Question

The income statement for Nadeen, Inc. shows income before income taxes \(\$ 700,000\), income tax expense \(\$ 210,000\), and net income \(\$ 490,000\). If Nadeen has 100,000 shares of common stock outstanding throughout the year, earnings per share is: (a) \(\$ 7.00\). (c) \(\$ 2.10\). (b) \(\$ 4.90\). (d) No correct answer is given.

Step-by-Step Solution

Answer

(b) $4.90.

Step 1: Identify Net Income

The net income for Nadeen, Inc. is given directly in the exercise. It is stated as \( \$490,000 \).

Step 2: Identify Shares Outstanding

The number of shares of common stock outstanding is also given in the exercise, which is 100,000 shares.

Step 3: Calculate Earnings Per Share (EPS)

Earnings Per Share (EPS) is calculated using the formula: \( \text{EPS} = \frac{\text{Net Income}}{\text{Shares Outstanding}} \). Substitute the known values into the formula: \( \text{EPS} = \frac{490,000}{100,000} = 4.90 \).

Step 4: Determine the Correct Option

From the options provided, the correct choice is (b) \( \$4.90 \).

Key Concepts

Net Income

Net income is a key indicator of a company's profitability within a given period. It represents the total earnings after all expenses, including taxes, interest, and operating costs, have been deducted from revenue. For Nadeen, Inc. in this exercise, the net income is given as \( \$490,000 \). This figure is crucial because it shows how much profit the company has made and is often used in financial analyses and decisions.

Understanding net income is important for investors because it:

• Determines the company's profitability.
• Influences investment decisions and stock prices.
• Provides insights into financial health and management efficiency.

Investors often look for stable or growing net income as a sign of a healthy company.

Income Statement

An income statement is a financial document that summarizes a company’s revenues, expenses, and profits over a specific period, such as a quarter or fiscal year. It provides users, such as investors and management, with a snapshot of the company’s financial performance.

For Nadeen, Inc., the income statement gives us crucial numbers such as income before income taxes (\( \\(700,000 \)), income tax expense (\( \\)210,000 \)), and ultimately, the net income (\( \$490,000 \)). This structured flow allows stakeholders to understand how the revenues are converted into net income.The income statement typically includes:

• Revenue: Total income received from sales and services.
• Expenses: Costs incurred in operating the business, including costs of goods sold, administrative expenses, taxes, etc.
• Net Income: Final profit after deducting all expenses from revenue.

This document is essential for evaluating a company's ability to generate profit efficaciously.

Shares Outstanding

Shares outstanding refer to the total number of shares currently owned by all shareholders, including share blocks held by institutional investors and restricted shares owned by the company’s officers and insiders. For Nadeen, Inc., the exercise specifies that there are 100,000 shares outstanding throughout the year.

The concept of shares outstanding is vital to various financial calculations, including the Earnings Per Share (EPS), which provides insight into the company's profitability on a per-share basis. The formula is: \[\text{EPS} = \frac{\text{Net Income}}{\text{Shares Outstanding}}.\]This metric is crucial because it:

• Helps investors gauge the performance of their investments relative to others.
• Reflects the portion of a company's profit allocated to each outstanding share of common stock.
• Assists in determining stock valuation and comparing with peers.

A higher EPS often signifies greater profitability and can indicate financial health, influencing investor perception and investment strategy.