Problem 25 - Accounting

Question

Staples and OfficeMax are two companies competing in the retail office supply business. OfficeMax had a net income of \(\$ 91,721,000\) for a recent year, while Staples had a net income of \(\$ 973,577,000\). OfficeMax had preferred stock of \(\$ 54,735,000\) with a preferred dividend of \(7.375 \%\) on that amount. Staples had no preferred stock. The outstanding common shares for each company were as follows: \begin{tabular}{lr} & Common Shares \\ \hline OfficeMax & \(73,142,000\) \\ Staples & \(720,528,000\) \end{tabular} a. Determine the earnings per share for each company. b. Evaluate the relative profitability of the two companies.

Step-by-Step Solution

Answer

Staples has an EPS of $1.35, higher than OfficeMax's $1.20.

Step 1: Calculate Preferred Dividends for OfficeMax

First, compute the preferred dividends for OfficeMax using the formula: \( \text{Preferred Dividend} = \text{Preferred Stock} \times \text{Preferred Dividend Rate} \). Substitute the given values: \( \\(54,735,000 \times 7.375\% = \\)4,035,206.25 \).

Step 2: Determine Net Income Available for Common Shareholders

For OfficeMax, subtract the preferred dividends from the net income to find the earnings available for common shareholders: \( \\(91,721,000 - \\)4,035,206.25 = \\(87,685,793.75 \). Staples has no preferred stock, so its net income available is the entire \( \\)973,577,000 \).

Step 3: Calculate Earnings Per Share (EPS) for Each Company

EPS is calculated as the net income available to common shareholders divided by the number of outstanding shares. For OfficeMax: \( \text{EPS} = \frac{\\(87,685,793.75}{73,142,000} = \\)1.20 \). For Staples: \( \text{EPS} = \frac{\\(973,577,000}{720,528,000} = \\)1.35 \).

Step 4: Compare EPS for Relative Profitability

Staples has a higher EPS of \\(1.35 compared to OfficeMax's \\)1.20, indicating that Staples is relatively more profitable per share than OfficeMax.

Key Concepts

Relative Profitability

When evaluating companies, the concept of relative profitability is crucial because it tells us how well a company is performing compared to its peers. In this context, profitability is often measured through the Earnings Per Share (EPS). EPS provides insight into how much profit a company generates on a per-share basis.
Staples and OfficeMax serve as great examples to illustrate this concept. Staples, with an EPS of \(1.35\), is more profitable per share than OfficeMax, which has an EPS of \(1.20\). This means that for every share of stock owned, a stakeholder receives more profit from Staples than they would from OfficeMax.
Relative profitability can be affected by several factors, including management efficiency, market conditions, and cost structure. A higher EPS suggests that a company is using its resources more efficiently to generate income.

Preferred Dividends

Preferred dividends play a crucial role when calculating earnings available to common shareholders, especially for companies with preferred stock. Preferred dividends are payments made to preferred shareholders who generally have priority over common shareholders in receiving dividends.
In the case of OfficeMax, preferred stock has a value of \(\\( 54,735,000\) and a dividend rate of \(7.375\%\), resulting in total preferred dividends of \(\\) 4,035,206.25\).
Because preferred dividends must be paid before dividends to common shareholders, these payments are subtracted from net income to determine earnings available for common shareholders. This is why, for OfficeMax, the calculation begins by reducing net income by the amount of preferred dividends, unlike Staples, which does not have preferred stock.

Net Income

Net income is the amount remaining after all expenses, taxes, and costs have been subtracted from total revenue. It's often referred to as the bottom line, and it represents a company’s profitability over a certain period.
For this exercise, OfficeMax's net income was \(\\( 91,721,000\), while Staples had a significantly larger net income of \(\\) 973,577,000\).
In comparing the net incomes of the two companies, it's essential to account for any preferred dividends that must be paid out. Net income minus these dividends gives us the earnings available for common shareholders. Staples' net income can be directly used as their earnings available for common shareholders, as they don't have preferred dividends to account for.

Common Shares

Common shares represent the ownership interests held by shareholders in a corporation. They have the right to vote on corporate matters and to share in any profits through dividends, depending on the company's profitability.
The number of common shares is vital when calculating EPS, as it shows how profits are distributed among shareholders. For this exercise, OfficeMax had \(73,142,000\) outstanding common shares, and Staples had \(720,528,000\) shares.
Earnings per share is calculated by dividing the net income available to common shareholders by the number of common shares. The larger the number of common shares, the thinner the net income is spread, potentially affecting EPS.