Question

On January 1, 2020, Carla Company issued 10-year, $1,980,000 face value, 6% bonds, at par. Each $1,000 bond is convertible into 15 shares of Carla common stock. Carla’s net income in 2020 was $479,400, and its tax rate was 20%. The company had 102,000 shares of common stock outstanding throughout 2020. None of the bonds were converted in 2020.

(a) Compute diluted earnings per share for 2020. (Round answer to 2 decimal places, e.g. $2.55.)

Diluted earnings per share

$enter diluted earnings per share rounded to 2 decimal places

(b) Compute diluted earnings per share for 2020, assuming the same facts as above, except that $1,020,000 of 6% convertible preferred stock was issued instead of the bonds. Each $100 preferred share is convertible into 5 shares of Carla common stock. (Round answer to 2 decimal places, e.g. $2.55.)

Diluted earnings per share

$enter diluted earnings per share rounded to 2 decimal places

Answer 1

First Calcuate the Basic EPS.

Basic EPS = Net Income/No of Shares

Basic EPS = $4.70 ($479,400/102,000)

*Assuming Net income of $479,400 is after tax.

a) Diluted EPS.

Formula for Diluted EPS

Diluted EPS = (Net Income + Interest)/(No of Shares+Converted Shares)

If Bonds are converted into shares interest will be saved.

First calculate convertable shares from bonds.

Each bond, Face value of $1,000 converted into 15 shares.

No of Bonds = 1,980 ($1,980,000/1,000)

Converted shares = 29,700 (1,980*15)

Next Calculate Interest after Tax.

Interest = $118,800 ($1,980,000*6%)

Tax = $ 23,760 ($118,000*20%)

Interest after tax = $95,040 ($118,800-$23,760)

Diluted EPS = $4.36 {($479,400+$95,040)/(102,000+29,700)}

Diluted EPS =$4.36.

b) Diluted EPS in case of Preferred Shares

Baisc EPS = (Net Income - Preferred Divided)/ No of Shares.

Preferred Dividend = $61,200( $1,020,000*6%)

Basic EPS = $4.10 {($479,400-$61,200)/ 102,000}

Diluted EPS = Net Income / (No of Shares+Converted Shares)

* Note : As preferred stock are convertable into equity stock, No dividend is payable on prefereed stock to arrive diluted EPS.

First let calculate no of Preferred stock converted into equity stock.

No of shares converted = 51,000 ($1,020,000/100*5)

Diluted EPS = $ 3.13   {$479400/(102,000+51,000)}

Diluted EPS =$3.13