Question

For the year ending December 31, 2020, Bad Year, Inc. reported Basis Earnings Per Share in the amount of $ 1.75, which was calculated as Net Income of $ 1,050,000 dividend by 600,000 weighted average commonshares outstanding. Bad Year, Inc. does not have a preferred stock outstanding, and did not pay any common dividends during 2020.
Throughout 2020, employees of Bad Year, Inc. owned 150,000 stock options, which entitled them to purchase 150,000 shares of Bad Year, Inc. common stock at a price of $ 40 per share. The options are currentlyexercisable, and expire on December 31, 2025. During 2020, the average price of Bad Year Common Stock was $ 25 per share.
In addition, Bad Year has Convertible Debt with a face value of $ 8,000,000 outstanding. This debt was issued "at par" on January 1, 2016, it has a coupon rate of 5% per year, and an expiration date of December 31,2030. The conversion option on the debt allows an owner to exchange $ 1,000 of face value debt for 50 shares of Bad Year common stock. Bad Year, Inc. currently pays income tax at a rate of 20%
Based on the information provided above, what is the "Diluted EPS"that Bad Year, Inc. should report for the fiscal year ending December 31, 2020?

A.$1.25

B.$1.37

C.$ 1.75

D.None of the above

Answer 1

Computation of potential Shares -

1. Assumed Stock options exercised at the beginning of the year

	Potential stock due to options	$ proceeds	shares
	Stock options exercised	$      6,000,000.00	150000
less	Own shares repurchased from proceeds of options @$25 per share ($6,000,000 / 25)	$     (6,000,000.00)	240000
	Antidilutive		-90000

As repurchased will be more than increase due to option exercised, stock options are antidilutive. Hence should be ignored.

2. Assumed Convertible Debt converted to common stock at the beginning of the year

Increase in numerator = Interest saved net of tax

= $8,000,000 x 5% x (1 - 0.2)

= $320,000

Increase in denominator = $8,000,000 / 1000 x 50 shares

= 400,000 shares

Now, Diluted EPS = Net income available to equity shareholders including increase due to potential stock

Weighted average number of equity shares outstanding + increase due to potential securities

= $1,050,000 + $320,000

600,000 + 400,000

= $1.37 per share

Hence optiob B is correct.

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