Hello Xabier,
When calculating the diluted earning per share we have to do the following adjustments to normal EPS formula:
- Increase the weighted average common shares outstanding amount by adding 30,000 shares
- Increase the net income (numerator) by the amount of the after-tax interest saved: $2,000,000 x 9% x (1 - 40%) = $108,000
- Convertible Preferred Stocks:
- Increase the weighted average common shares outstanding amount by adding 20,000 shares
- Preferred dividends are no longer subtracted from net income (Because no more preferred stocks in this dilution, all converted into common stocks)
Diluted Earnings Per Share = $970,000 + $108,000 / (90,000 + 30,000 + 20,000) = $7.70
Kindly note the followings:
- The conversion ability is the key concept to drive the diluted EPS formula.
- Normal preferred socks >>> Subtract dividends from net income ... Convertible >>> Ignore dividends
- Paid dividends of $2.50 for preferred stocks during 20X1 is not relevant to solution. (Misleading info)
- There is some hints to ignore preferred stocks dividends ?? No par value, No $ amount, No interest rate.
- Even assuming $100 par value will not give the real interest % according to $2.50 dividend paid.
Hope this will be clear & helpful.
Kind regards
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Samer Ahmad, FMVA, SCA
Kuwait
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Original Message:
Sent: 05-23-2020 09:25 AM
From: Xabier Andoni Sarmiento Aznar
Subject: CMA Part 1 - Exercise Question #101715
At December 31, 20X1 and 20X0, Gravin Corporation had 90,000 shares of common stock and 20,000 shares of convertible preferred stock outstanding, in addition to 9% convertible bonds payable in the face amount of $2,000,000. During 20X1, Gravin paid dividends of $2.50 per share on the preferred stock. The preferred stock is convertible into 20,000 shares of common stock. The 9% convertible bonds are convertible into 30,000 shares of common stock. Net income for 20X1 was $970,000. Assume an income tax rate of 40%.
How much is the diluted earnings per share for the year ended December 31, 20X1?
Answers:
a) 7.70
b) 8.21
c) 9.35
d) 10.22
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Xabier Sarmiento Aznar
Madrid, Spain
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