Question

A firm has basic earnings per share of $1.90. If the tax rate is 30%, which of the following securities would be dilutive? (Circle the best answer.) a. Convertible 5% bonds, issued at par, with each $1,000 bond convertible into 20 shares of common stock. b. Convertible 6% bonds, issued at par, with each $1,000 bond convertible into 20 shares of common stock. c. Cumulative convertible 4%, $100 par, preferred stock, issued at par, with each preferred share convertible into two shares of common stock. d. Cumulative convertible 3%, $100 par, preferred stock, issued at par, with each preferred share convertible into one share of common stock. e. Cumulative 7%, $50 par preferred stock.

Answer 1

As per the study i can figure out the points

EPS=$1.90

Tax Rate=30%

and options given

A) Convertible 5% bonds, issued at par, with each $1,000 bond convertible into 20 shares of common stock.

B) Convertible 6% bonds, issued at par, with each $1,000 bond convertible into 20 shares of common stock.

C) Cumulative convertible 4%, $100 par, preferred stock, issued at par, with each preferred share convertible into two shares of common stock.

D) Cumulative convertible 3%, $100 par, preferred stock, issued at par, with each preferred share convertible into one share of common stock.

E) Cumulative 7%, $50 par preferred stock.

as per my choice

A is correct because the effect of assuming conversion of the 5% convertible bond would have the following effects on the numerator and denominator ($50 interest – $15 tax expense)/20 shares = $1.75 to 1 ratio, which would reduce the basic EPS of $1.90

B is incorrect because the effect of assuming conversion of the 6% convertible bond would have the following effects on the numerator and denominator ($60 interest – $18 tax expense)/20 shares = $2.1 to 1 ratio, which would increase the basic EPS of $1.90.

C is incorrect because the effect on the ratio would be ($100* 4%)/2 = $2 to 1 ratio, which also is antidilutive.

D is incorrect because the effect on the ratio would be ($100* 3%)/1 = $3 to 1 ratio, which also is antidilutive

E is incorrect because the preferred stock is not convertible and would not be used to calculate diluted earnings per share.