Question

Convertible Securities and Earnings per Share

Percy Company has 15,000 shares of common stock outstanding during all of 2019. It also has 2 convertible securities outstanding at the end of 2019. These are:

1. Convertible preferred stock: 1,000 shares of 9%, $100 par, preferred stock were issued in 2015 for $140 per share. Each share of preferred stock is convertible into 3.5 shares of common stock. The current dividends have been paid. To date, no preferred stock has been converted.
2. Convertible bonds: Bonds with a face value of $100,000 and an interest rate of 10% were issued at par on July 1, 2019. Each $1,000 bond is convertible into 35 shares of common stock. To date, no bonds have been converted.

Percy earned net income of $54,000 during 2019. Its income tax rate is 30%.

Required:

a. Compute the 2019 diluted earnings per share. Round your answer to two decimal places.

$  per share

b. What basic earnings per share amount would Percy report on its 2019 income statement? Round your answer to two decimal places.

$  per share

Answer 1

Solution: Basic EPS would be Earning available to equity shareholders divided by basic shares outstanding.

That is ($54,000 - $9,000 preferred dividend) /15,000 = $45,000 / 15,000 = $3 per share

This is Basic EPS.

For Diluted we have to make two adjustments: adjust what earnings would be without those diluted securities and then what diluted shares would be if you converted those instruments into common stock.

Diluted Earnings = (net income – current preferred dividends) + convertible preferred dividend + [convertible debt interest * (1-t)]

That is = ($54,000 - $9,000) + ($9 * 1000) + [10% * $100,000 * 6/12 * (1-0.30)]

= $45,000 + $9,000 + $3,500 = $57,500

Diluted Shares Outstanding = weighted average shares + shares from conversion of convertible preferred shares + shares from conversion of convertible debt+ shares issuable from stock options.

that is = 15,000 + (1,000 * 3.5) + (100 * 35 * 6/12) + 0

= 15,000 + 3,500 + 1,750 = 20,250

Diluted EPS is = $57,500 / 20,250 = $2.84 per share

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