Question

An excerpt from the statement of financial position of Twilight Limited follows:

TWILIGHT LIMITED
Selected Statement of Financial Position Information
At December 31, 2020
Long-term debt
	Notes payable, 10%			$5,000,000
	4% convertible bonds payable			2,000,000
	6% convertible bonds payable			3,000,000
		Total long-term debt		$10,000,000
Shareholders' equity
	$0.68 cumulative, no par value, convertible preferred shares (unlimited number of shares authorized, 600,000 shares issued and outstanding)			$3,000,000
	Common shares, no par value (8,000,000 shares authorized, 3,000,000 shares issued and outstanding)			25,000,000
	Contributed surplus			200,000
	Retained earnings			7,000,000
		Total shareholders’ equity		$35,200,000

Notes and Assumptions
December 31, 2020

1.		Options were granted/written in 2019 that give the holder the right to purchase 100,000 common shares at $8 per share. The average market price of the company’s common shares during 2020 was $14 per share. The options expire in 2028 and no options were exercised in 2020.
2.		The 4% bonds were issued in 2019 at face value. The 6% bonds were issued on June 1, 2020, at face value. Each bond has a face value of $1,000 and is convertible into 100 common shares.
3.		The convertible preferred shares were issued at the beginning of 2020. Each share of preferred is convertible into one common share.
4.		The average income tax rate is 25%.
5.		The common shares were outstanding during the entire year.
6.		Preferred dividends were not declared in 2020.
7.		Net income was $2,500,000 in 2020.
8.		No bonds or preferred shares were converted during 2020.

Determine an incremental per share effect for 4% bonds. (Round earnings per share to 2 decimal places, e.g. 15.25.) Potentially dilutive security Incremental Numerator Effect Incremental Denominator Effect EPS 4% Bonds $ $

Calculate the after-tax interest paid on the 6% bonds. After-tax interest on 6% bonds converted $

Determine an incremental per share effect for 6% bonds. (Round earnings per share to 2 decimal places, e.g. 15.25.) Potentially dilutive security Incremental Numerator Effect Incremental Denominator Effect EPS 6% Bonds $ $

Rank the potentially dilutive securities from most dilutive to least dilutive. 4% Bonds

6% Bonds
$0.68 Preferred shares
Options

Calculate diluted earnings per share for 2020. (Round earnings per share to 2 decimal places, e.g. 15.25.) Numerator Denominator EPS Basic $ $

Sub Total

Sub Total

Sub Total

Answer 1

Determine an incremental per share effect for 4% bonds. (Round earnings per share to 2 decimal places, e.g. 15.25.)
Potentially dilutive security	Incremental	Incremental	EPS
	Numerator Effect	Denominator Effect
4% Bonds	$    60,000.00	200,000.00	$           0.30
After-tax interest = $2,000,000 x 4% x (1-25%)
# of bonds converted into Common shares = (2,000,000/1000)*100
Calculate the after-tax interest paid on the 6% bonds.
After-tax interest on 6% bonds converted = $3,000,000 x 6% x 50% X (1-25%)	$    67,500.00		$
Determine an incremental per share effect for 6% bonds. (Round earnings per share to 2 decimal places, e.g. 15.25.)
Potentially dilutive security	Incremental	Incremental	EPS
	Numerator Effect	Denominator Effect
6% Bonds	$    67,500.00	150,000.00	0.45
# of bonds converted into Common shares = (3,000,000/1000)*100 * 50%
Rank the potentially dilutive securities from most dilutive to least dilutive.
4% Bonds	2nd
6% Bonds	3rd
$0.68 Preferred shares	4th
Options	1 st
Calculate diluted earnings per share for 2020. (Round earnings per share to 2 decimal places, e.g. 15.25.)
	Numerator	Denominator	EPS
Basic	2,092,000.00	3,000,000.00	$           0.70
Options (calculated below)		42,857.14
Sub Total	2,092,000.00	3,042,857.14	$           0.69
4% Bonds	$    60,000.00	200,000.00
Sub Total	2,152,000.00	3,242,857.14	$           0.66
6% bonds	$    67,500.00	150,000.00
Diluted Earnings Per Share	2,219,500.00	3,392,857.14	$           0.65
Preferred shares	$  408,000.00	600,000.00
	2,627,500.00	3,992,857.14	$           0.66
Use treasury stock method to determine incremental shares outstanding
Proceeds from exercise of options	800,000.00
Shares issued upon exercise of options	100,000.00
Shares purchasable with proceeds (Proceeds ÷ Average market price) = (800000/14)	57,142.86
Incremental shares outstanding	42,857.14