Question

Data for the Dusty Co. at the end of 2020 is listed below. All bonds and preferred stock were issued at par.

1. $500,000 10 year 6% convertible bond issued on 1/1/13 with conversion terms of 80 shares of common for each $1,000 bond.

2. $1,000,000 20 year 7% convertible bond issued on 1/1/14 with conversion terms of 40 shares of common for each $1,000 bonds.

3. $1,000,000 (10,000 shares) 7% preferred stock $100 par issued on 1/1/15 with conversion terms of 10 shares of common for each share of preferred.

4. $800,000 25 year 9.5% convertible bond issued 6/30/20 with conversion terms of 100 shares of common stock for each $1,000 bond.

5. Common stock outstanding on 12/31/20 600,000 shares

6. Net income for 2020 $1,525,000

7. Income tax rate 40%

Required:

Compute the basic and diluted EPS for 2020 assuming no additional shares of common stock were issued during the year.

PLEASE SHOW ALL WORK!

Answer 1

Step 1 :Computation of preference dividend

Preference dividend

= Par value of preference shares × Rate of interest

= $1,000,000 × 7%

= $70,000

Step 2 : Computation of Income available for common stock share holder

Particulars Amount (in $'s)

Net income 1,525,000

(-) Interest on bonds

(500,000 × 6%+ 1,000,000 × (176,000)

7% + 800,000 × 9.5%)

(-) Preference dividend (70,000)

Income before tax 1,279,000

(+) Tax benefit on

Preference dividend. 28,000

(70,000× 40%)

Income before tax 1,307,000

(-) Tax @ 40% (522,800)

EARNING AVALIABLE FOR

COMMON STOCK HOLDER. 784,200

Step 3: BASIC EPS COMPUTATION

EPS = Earnings available for common stock holder / No.Of basic shares

= $784,200/600,000

= $1.31per share

Therefore basic EPS for 2020 is $1.31

Step 4 : Computation of Income available for Common stock holder (for the purpose of Diluted EPS)

PARTICULARS. AMOUNT ( in $'s)

Net income 1,525,000

( - ) Income tax paid. (610,000)

Income available for common

stock holders 915,000

Step 5 : Computation of Equivalent Number of shares

S.No. Particulars. Number of

Shares

1. $500,000 ,10years bonds. 40,000

(500,000 × 80 / 1000)

2. $1000,000 ,20 years bond. 40,000

( 1,000,000 × 40 / 1,000)

3. Preference stock. 100,000

(10,000 × 10)

4. $800,000 ,25 years bonds. 80,000

(800,000 × 100 / 1,000)

Total number of equivalent shares = 260,000

( 40,000+40,000+100,000+80,000)

Step 6 : Computation of Diluted EPS for 2020

Diluted EPS = Income available for common stock holder ( step 4) /Equity stock + Number of equivalent common stock (step 5)

= $915,000/600,000+260,000

=$915,000/860,000

=$1.06

Diluted EPS for 2020 is $1.06