Question

Choco Company had the following capital structure at January 1, 2018:

Outstanding

Ordinary shares, 600,000 shares $7,200,000

10% stated interest rate convertible bonds issued at par;

each $1,000 bond is convertible into 80 ordinary shares $5,000,000

During 2018, Choco had the following share transactions:

May 1 Issued 50,000 ordinary shares for $30 per share.

Sep. 1 Redeemed 100,000 ordinary shares at $35 per share.

Nov. 1 Converted $2,000,000 of bonds. Net income for 2018 was $1,900,000.

The income tax rate was 32%.

Required: Compute the basic and diluted earnings per share for Choco for 2018 (Round to 2 decimal places).

Answer 1

Basic earnings per share = (Net income – Preferred dividends) / Weighted average shares outstanding

                                            = ($1,900,000 – $0) / 626,667

                                            = $3.03

Diluted earnings per share = [Net income – Preferred dividends + {Interest expense × (1 – Tax rate)}] / (Weighted average shares outstanding + Convertible bonds converted into shares)

                                             = [$1,900,000 – $0 + {$16,000 × (1 – 0.32)}] / (626,667 + 160,000)

                                             = [$1,900,000 – $0 + {$16,000 × (1 – 0.32)}] / 786,667

                                             = $1,910,880 / 786,667

                                             = $2.43

Interest expense = Converted bonds × Interest rate

                           = 160,000 × 10%

                           = $16,000

Working note-

Formula sheet is given below-