Question

The Cain Company owns 800 of the 1000 shares of the Able Company which it bought at book value.

Able Company does not pay any dividends and Cain Company uses the initial value method to account for its investment in Able.

Information for 2016 is as follows: CAIN * ABLE

INCOME BEFORE INTEREST AND TAX $900,000 $200,000

INTEREST $100,000 $60,000

INCOME BEFORE TAXES $800,000 $140,000

TAXES 30% $240,000 $42,000

INCOME $560,000 $98,000

* UNCONSOLIDATED AMOUNTS

CAIN HAS 50,000 SHARES OF STOCK OUTSTANDING

ABLE'S INTEREST EXPENSE IS THE RESULT OF A $1,000,000 6% CONVERTIBLE DEBT. THE DEBTHOLDER CAN CONVERT THIS INTO 600 SHARES OF ABLE STOCK

REQUIRED:

A) IF THE CONVERTIBLE DEBT IS ANTI-DILUTIVE WHAT IS THE EPS OF CAIN FOR THE YEAR?

B) IF THE CONVERTIBLE DEBT IS DILUTIVE WHAT IS THE EPS OF CAIN FOR THE YEAR?

Answer 1

A) IF THE CONVERTIBLE DEBT IS ANTI-DILUTIVE WHAT IS THE EPS OF CAIN FOR THE YEAR.

EPS OF CAIN FOR THE YEAR = (Net Income after tax of Cain + 80 % of the Net Income after tax of Able) / Stock Outstansi[ng of CAIN

= [$ 560,000 + ($ 98000 * 80/100)] / 50,000 Shares

= [$ 560,000 + $ 78,400] / 50,000 Shares

= $ 638,400 / 50,000 Shares

= $ 12.768 Per Share

B) IF THE CONVERTIBLE DEBT IS DILUTIVE WHAT IS THE EPS OF CAIN FOR THE YEAR.

Total No of Shares including Covertable debentures of ABLE

= Existing Share Holder + Convertable Debenture

= 1000 + 600

= 1600 Shares

New Cain Holding Percentage = No of Share Hold / Total No of share including Convertable Debenture * 100

= 800 /1600 *100

= 50%

Revised Net Income after Tax= (Income Before Tax + Interest ) - 30% of (Income Before Tax + Interest )

= ($ 140,000 + 60,000) - ($ 200,000 * 30/100)

= $ 200,000 - $ 60,000

= $ 140,000

EPS OF CAIN FOR THE YEAR = (Net Income after tax of Cain + 50 % of the Net Income after tax of Able) / Stock Outstansi[ng of CAIN

= [$ 560,000 + ($ 140,000 * 50/100)] / 50,000 Shares

= [$ 560,000 + $ 70,000] / 50,000 Shares

= $ 610,000 / 50,000 Shares

= $ 12.20 Per Share.if Convertible Debt is Dilutive