Question

Computation of Basic and Diluted EPS) The information below pertains to Barkley Company for 2018.

Net income for the year
7% convertible bonds issued at par ($1,000 per bond); each bond is convertible into

30 shares of common stock
6% convertible, cumulative preferred stock, $100 par value; each share is convertible

into 3 shares of common stock Common stock, $10 par value
Tax rate for 2018
Average market price of common stock

$1,200,000

2,000,000

4,000,000 6,000,000 40% $25 per share

There were no changes during 2018 in the number of common shares, preferred shares, or convertible bonds outstanding. There is no treasury stock. The company also has common stock options (granted in a prior year) to purchase 75,000 shares of common stock at $20 per share.

Instructions

(a) Compute basic earnings per share for 2018.

(b) Compute diluted earnings per share for 2018.

*PLEASE SHOW ALL YOUR WORK*

Answer 1

(a) Basic earnings per share for 2018:

Net income = $1,200,000

Preferred dividend = 4,000,000*6% = $240,000

Weighted average common shares outstanding = 6,000,000/10 = 600,000

Basic earnings per share =

(Net income - Preferred dividend) / Weighted average common shares outstanding

= ($1,200,000 - $240,000) / 600,000

= $1.6

(b) Diluted earnings per share for 2018:

1. Interest savings net of tax = $2,000,000 x 7% x (1-0.4) = $84,000

2. Incremental shares = [ (Market price - Option price) / Market price ] x No.of options

= [ (25-20) / 25 ] x 75000

= 15,000 shares

3. Conversion of bonds into shares = [ $2,000,000 / 1000 ] x 30 shares per bond = 60,000 shares

4.  Preferred stock is not assumed to be converted since conversion would be antidilutive.

Diluted earnings per share =

(Net Income - Preferred Dividend) + Interest savings

Average shares + Potentially dilutive common shares

=[ (12,000,000 - 240,000) + 84000¹ ] / (600,000 + 15000² + 60000³)

= 1044000 / 675000

= $1.55