Question

96. The Dunlop Corporation reported basic EPS of $3.50 for the year ended December 31, 2018; the denominator used in the basic EPS calculation was 360,000 shares. Dunlop’s marginal income tax rate is 40%. Dunlap had the following convertible securities outstanding during the entire year:

8% convertible preferred stock with a total par value of $1,000,000; the preferred stock is convertible into 22,000 shares of common stock.

10% convertible bonds with a total par value of $6,000,000; the convertible bonds are convertible into 120,000 shares of common stock.

Required:

Calculate the diluted EPS. (Hint: First test each security separately for dilution.)

Answer 1

Solution:

Basic EPS = $3.60

Weighted average outstanding shares = 360000

Earning for common shareholders = 360000 * $3.50 = $1,260,000

Conversion of Preferred stock:

Adjusted net income = $1,260,000 + ($1,000,000*8%) = $1,340,000

Adjusted weighted average outstanding share after conversion = 360000 + 22000 = 382000 shares

EPS after conversion of preferred stock = $1,340,000 / 382000 = $3.51

As there is no dilusion in EPS after conversion of preferred stock therefore same will not be presented for computation of diluted EPS in financial statements.

Conversion of bond:

Reduction in interest expense (Net of tax) = $6,000,000 * 10% ( 1-0.40) = $360,000

Adjusted net income = $1,260,000 + $360,000 = $1,620,000

Adjusted shares after conversion = 360000 + 120000 = 480000 shares

Diluted EPS =$1,620,000 / 480,000 = $3.375

As EPS is decreasing after conversion of bond, therefore

Diluted EPS to be presented in financial statement = $3.375 per share