Question

Philip C. Company has 400,000 shares common stock outstanding. In addition, Philip also had 100,000 shares of $100 par 5% convertible preferred stock. Each share of preferred stock can be converted into 2 shares of common stock. Net income for the year was $2,000,000 and the tax rate is 30%.

Basic EPS ____________________   Fully-Diluted EPS __________________  

Answer 1

Calculation of Basic EPS

(It is assumed that the given net income of $2,000,000 is after tax income.)

Preferred Dividends = Par value of Preferred Stock*5%

= (100,000 shares*$100 par)*5% = $10,000,000*5% = $500,000

Earnings available for Common stock = Net Income - Preferred Dividends

= $2,000,000 - $500,000 = $1,500,000

Outstanding common shares = 400,000

Basic EPS = Earnings available for Common stock/Outstanding common shares

= $1,500,000/400,000 = $3.75 per share

Calculation of Fully-Diluted EPS

If Preferred shares converted into common stock, then the common stock will be increased by 200,000 shares (i.e. 100,000 shares*2 share) and the earnings available for common stock is also increased by preferred dividends of $500,000 (as all the preferred shares will be converted in common shares).

Earnings available for Common stock = $1,500,000+$500,000 = $2,000,000

Outstanding common shares = 400,000+200,000 = 600,000 shares

Fully Diluted EPS = $2,000,000/600,000 = $3.33 per share