Question

Carla Corporation had a net income for the current year ending December 31, 2021 of $1,204,500. Throughout 2021 the following items were outstanding:

●		413,000 common shares
●		18,500 Class A $3 cumulative preferred shares that were convertible to common shares at a rate of 1:1
●		49,500 Class B $4 non-cumulative preferred shares that were convertible at a rate of one common share for every two preferred shares.
●		$551,000, 8% bonds that were convertible to 14,500 common shares
●		$303,000, 10% bonds convertible to 9,000 common shares

No dividends were declared or paid in 2021. Carla’s tax rate is 25%.

Determine an incremental per share effect for Class B preferred shares. (Round earnings per share to 2 decimal places, e.g. 15.25.)

Potentially dilutive security		Incremental Numerator Effect		Incremental Denominator Effect		EPS
Class B Preferred shares		$				$

Answer 1

Class B Preferred shares on being converted to equity, would lead to an increase in after tax earning available to equity shareholders by $4 * 49,500 = $198,000

Hence, incremental Numerator Effect = $198,000

One equity share would be issued for every 2 preferred shares of Class B, implying that after conversion, they would amount to 24,750 equity shares.

Hence, incremental Denominator Effect = 24,750 shares.

Note:- In absence of any other base EPS, the basic EPS would be adjusted with the incremental figures to find the incremental effect on EPS. Kindly note that if this is a part of a chain question with many sub-parts the the incremental figures need to be added to the last eps calculations and the current approach would result in a potentially wrong incremental EPS.

Basic EPS = (Earnings) / Shares = ($1,204,500 - $3*18,500 - $4*49,500) / 413000 = $951,000 / 413,000 = $2.30 per share

Incremental EPS = ($951,000 + $198,000) / (413,000 + 24,750) = $1,149,000 / 437,750 = $2.62 (Implying Anti-Dilutive nature)

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