Question

Garfun, Inc., owns all of the stock of Simon, Inc. For 2018, Garfun reports income (exclusive of any investment income) of $480,000. Garfun has 80,000 shares of common stock outstanding. It also has 5,000 shares of preferred stock outstanding that pay a dividend of $15,000 per year. Simon reports net income of $290,000 for the period with 80,000 shares of common stock outstanding. Simon also has a liability for 10,000 of $100 bonds that pay annual interest of $8 per bond. Each of these bonds can be converted into three shares of common stock. Garfun owns none of these bonds. Assume a tax rate of 30 percent.

What amount should Garfun report as diluted earnings per share? (Round your intermediate percentage value to the nearest whole number and the final answer to 2 decimal places.)

Answer 1

Net Income

To determine the profitability of an entity, net income should be calculated. In its simplest form, net income is calculated by subtracting total expenses from total revenue.

The formula to calculated diluted earnings per share is:

(Net Income - Preferred Dividends + adjustments for diluted securities)/(weighted average shares of common stock + shares represented by diluted securities).

The individual elements are calculated as follows:

a) Net Income: $480,000 (as stated)

b) Preferred Dividends: $15,000 (as stated)

c) adjustments for diluted securities:

First, we'll calculate Simon's diluted EPS. (We add 30,000 to the denominator since we have 3 shares each for each of 10,000 $100 bonds)

(290,000)/(80,000 + 30,000)=2.63636 (This is Simon's diluted EPS.)

Garfun own's 80,000 shares, so we multiply Simon's diluted EPS x 80,000 total shares owned by Garfun:

80,000 x 2.63636=210,909.10 (This is Garfun's share of Simon's diluted EPS.)

Simon's net income:$290,000

Since the share of diluted earnings is lower, we will reduce the numerator of Garfun's EPS by the difference of the above two figures:-290,000+210,909.10

d) weighed average shares of common stock: 80,000 (as stated)

e) shares represented by diluted securities: 0 (The preferred shares are not designated as convertible.)

Therefore, the calculation for diluted EPS for Garfun is:

(480,000-15,000-290,000+210,909.10)/80,000=$4.82