Question

Hello This is my question tonight.

Sandhill Corporation had net income of $51,200 for the year ended December 31, 2020, and a weighted average number of common shares outstanding of 14,700. The following information is provided regarding the capital structure:

1.		7% convertible debt, 240 bonds each convertible into 41 common shares. The bonds were outstanding for the entire year. The income tax rate is 35%. The bonds were issued at par ($1,000 per bond). No bonds were converted during the year.
2.		4% convertible, cumulative $110 preferred shares, 1,100 shares issued and outstanding. Each preferred share is convertible into 3 common shares. The preferred shares were issued at par and were outstanding the entire year. No shares were converted during the year. Calculate the income effect of the dividends on preferred shares. Dividends on preferred shares $ Calculate the basic earnings per share for 2020 Basic earnings per share $ Calculate the after-tax interest paid on the 7% bonds. After-tax interest on bonds converted $ Thank You

Answer 1

1. Income effect of the dividends on preferred shares:

Cumulative preference shares outstanding during the year = 1,100 shares

Par value of the preference shares = $110 per share

Preferred rate of dividend = 4%

Dividends on preferred shares = 1,100 shares * $110 per share * 4% = $4,840

Therefore the preferred dividend for the year is $4,840. The preferred dividend will deducted from the Net profit for calculation of Basic Earnings Per Share (EPS). The will decrease the net income by $4,840. Hence net income after preferred dividend is $46,360 ($51,200 - $4,840).

2. Calculation of Basic Earnings Per Share (EPS):

Basic Earnings Per Share (EPS) = Net profit or loss for the period attributable to Equity Shareholders / Weighted Average Number of Common shares outstanding during the period

	$
Net income before tax	$51,200
Less: Tax at 35% ($51,200 * 35%)	17,920
Net income after tax ($51,200 - $17,920)	33,280
Less: Preference dividend + Tax, if any (Note 1 above)	4,840
Net profit attributable to Equity Shareholders ($33,280 - $4,840)	28,440
Number of Common shares outstanding during the period	14,700
Basic Earnings Per Share (EPS) ($28,440 / 14,700)	1.93 per share

Note:

1. It is assumed that the net income is after interest but before taxes.

2. In the given question dividend distribution tax is not mentioned and hence it is ignored.

3. Convertible Debt and Convertible preferred stock is not converted into common stock during the year.

3. Calculation of after-tax interest paid on the 7% bonds:

Number of convertible bonds issued = 240 bonds

Par value of the bond = $1,000 per bond

Value of convertible bonds = 240 bonds * $1,000 per bond = $240,000

Interest paid on convertible bonds = $240,000 * 7% = $16,800

Tax rate, t = 35%

After-tax interest paid for convertible bonds = $16,800 (1 - 0.35) = $16,800 * 0.65 = $10,920.