Question

Sweet Horizon Corp had the following items, all of which were outstanding throughout the entire fiscal year ending September 30, 2021:

●		750,000 common shares
●		290,000 $3 cumulative, no-par value preferred shares
●		Options to purchase 110,000 common shares at $13 per share. The average market price of Sweet’s common shares during the year was $20 per share. None of the options were exercised or expired during fiscal 2021
●		9% bond with a face value of $2,000,000, convertible to 55,000 common shares.

Sweet’s net income for fiscal 2021 was $7,995,000, and its tax rate was 15%. Preferred dividends had been paid in all previous fiscal years.

Calculate the income effect of the dividends on preferred shares.

Dividends on preferred shares

=

Calculate Sweet’s basic earnings per share for the year. (For simplicity, ignore the requirement to record the debt and equity portions of the convertible bond separately).

Basic earnings per share

=

Calculate the after-tax interest paid on the 9% bonds.

After-tax interest on bonds converted

=

Determine an incremental per share effect for 9% bonds.

Potentially dilutive security		Incremental Numerator Effect		Incremental Denominator Effect		EPS
9% Bonds		$				$

Calculate the proceeds from assumed exercise of options.

Proceeds from exercise of options

$

Calculate the incremental shares oustanding upon the exercise of options.

The incremental shares oustanding upon the exercise of options

=

Rank the potentially dilutive securities from most dilutive to least dilutive.

9% bonds		Rank 1Rank 2Anti-dilutive
Options		Rank 1Rank 2Anti-dilutive

Calculate Sweet’s diluted earnings per share for the year.

		Numerator		Denominator		EPS
Basic EPS		$				$
9% bondsOptions
Sub Total						$
9% bondsOptions
Sub Total		$				$

Diluted EPS

Answer 1

1. Income effect of the dividends on preferred shares

.

dividends on preferred shares = 290000 * 3 = 8700000

.

2. Basic Earnings per share ( Basic EPS )

Basic EPS =   Earnings available for common stock holders / Total o/s shares during the year.

.

Earnings available for common stock holders = Net income - preferred dividend = 7995000 - 870000 = 7125000

Total o/s shares during the year. = 750000 share

.

Basic EPS = 7125000 / 750000 = $9.5 per share

.

3. After tax interest on 9% Bonds

After tax interest = Interest (1-tax rate)

.

Interest = 2000000 * 9% = 180000

Tax rate = 15%

.

After tax interest = $180000 (1- 0 .15)

After tax interest = 180000 * 0.85

After tax interest = $153000

.

4. Incremental EPS - 9% Bonds

.

Potentially dilutive security	Incremental numerator effect (A)	Incremental Denominator effect (B)	EPS = (A/B)
9% Bond	$153000	55000	$2.7818

Incremental numerator effect = after tax interest = 153000

Incremental Denominator effect = equivalent number of common stocks = 55000

.

5.  Proceeds from assumed exercise of option = $13 * 110,000

= $1,430,000

.

Incremental shares outstanding upon the exercise of option =

Under Treasury stock method

Share repurchased using proceeds = 1430000 / 20 = 71500

So needed new Incremental shares issue = 110000 - 71500 = 38500

.

Incremental shares outstanding upon the exercise of option = 38500

.

6.

Rank the potentially dilutive securities from most dilutive to least dilutive.
9% bonds	Rank 2
Options	Rank 1 - Because It has no numerator effect, so it is most dilutive

.

7.   Calculate Sweet’s diluted earnings per share for the year

.

.	Numerator	Denominator	EPS
Basic EPS	$7125000	750000	$9.5
Options	0	38500
Sub Total	$7125000	788500	$9.04
9% bonds	$153000	55000
Sub Total	$7278000	843500	$8.63
Diluted EPS	$8.63