Question

A firm reported Net Income of $500,000. They have 100,000 shares of common stock with a price of $60 per share and 20,000 shares of preferred stock that pays a dividend of $6 per year. They have 2,000 convertible bonds with a face value of $1,000 and a 9% coupon rate. Each bond can be converted into 25 shares of stock. They have also issued 10,000 warrants that allows the owner to purchase stock for $50 per share. The tax rate is 25%. What is the difference between their Basic EPS and their fully diluted EPS (you have to solve for both).

a) $.23             b) $.41              c) $.82            d) $1.23       

Answer 1

Basic EPS = Profits attributable to common shareholders / No. of outstanding common shares

= [$500,000 - ($6 x 20,000)] / 100,000 = $380,000 / 100,000 = $3.80

Fully Diluted EPS = Profits attributable to common shareholders / (weighted average number of shares outstanding + the conversion of any in-the-money options, warrants, and other dilutive securities)

Net Increase in Shares for warrants = [n(M - E)] / M

n = No. of Shares Issuable;

M = Market Price of Shares

E = Exercise Price of Warrants

Net Increase in Shares for warrants = [10,000($60 - $50)] / $60 = $100,000 / $60 = 1,666.67 shares

Profits attributable to common shareholders = Net Income - Preferred Dividend + [Convertible Debt Interest x (1 - t)]

= $500,000 - ($6 * 20,000) + [(2,000 x $1,000 x 9%) x (1 - 0.25)]

= $500,000 - $120,000 + $135,000 = $515,000

Convertible Debt Shares = 2,000 x 25 = 50,000 shares

Fully Diluted EPS = $515,000 / [100,000 + 1,666.67 + 50,000] = $515,000 / 151,666.67 = $3.39

Difference = Basic EPS - Fully Diluted EPS = $3.80 - $3.39 = $0.41

Hence, Option "B" is correct.