Question

Crystal Corporation earned net income of $750,000 in 2016. It has a complex capital structure as follows: 10,000 shares outstanding of 10%, $100 preferred stock, and 150,000 shares issued of $5 common stock. There is also 20,000 common stock in the treasury. The preferred stock can be converted into 25,000 shares of common. In addition Crystal has Bonds Payable of $250,000 that pay interest of 8% and can be converted into 10,000 shares of common stock. The applicable federal income tax rate is 40%.

Calculate the basic earnings per share for 2016.

Calculate the diluted earnings per share for 2016.

Answer 1

Working Note = Calulation for checking dilutive and antidilutive EPS to determine
order of preference
Bonds	Interest net of tax		12000	A
	No. of common stock to be converted from Bonds		10000	B
	EPS on Increased stock		1.2	=A/B	Most dilutive
Preference shares
	Preference dividend		100000	A
	No. of common stock to be converted from preferred stock		25000	B
	EPS on Increased stock		4	=A/B
Crystal Company
Computation of Basic & Diluted earning per share for the year from the table given below
	Numerator	Denominator	=	Earnings per share
Basic	750000	130000	=	5.77
Diluted	762000	140000	=	5.44
Note : Treasury stock are not to be considered for calculation of EPS
		Net Income	Outstanding common stock	Earning Per share
As reported		750000	130000	5.769231	basic Earning per share
Add : 8% Bonds Payable		12000	10000
Total & Revised Earning per share		762000	140000	5.442857	Dilutive
Add : 10% preferred stock		100000	25000
Total & Revised Earning per share		850000	155000	5.483871	Anti-dilutive
(Note : One has to stop the calculation once anti-dilution starts and diluted earning per share
is determined above the anti-dilutive figure)
Since, 8% Bonds payable are most dilutive as per below table, it has been considered first for
calculation.
Interest on bonds added to net income is arrived after taking into tax effect, since the interest is
an expense which qualify for tax deduction. While preferred dividend is not tax deductable, so it
is taken without tax effect.
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