Question

The Smith Company had a net income for the year of $4,000 and had 2,000 shares of common stock outstanding during the year. Below are three potential diluters. 1. 10% convertible bonds that, if converted, would reduce after-tax interest expense by $800 and would add 1,000 incremental common shares to the denominator of EPS. 2. Stock options that, if exercised, would not change the numerator of EPS but would add 1,000 incremental common shares to the denominator. 3. 7% convertible preferred stock that, if converted, would increase the numerator of EPS by $700 and would add 500 incremental common shares to the denominator

Answer 1

Ans:

Baisc EPS:

Net Income/ common outstanding shares

=$4,000/2,000 = $2 per share.

Diluted EPS:

Net income: $4,000

Reduce in after tax Interest expense if converted to stock; $800

Increase in numerator if 7% preferred stock converted to common stocks: $700

Total net income after conversion: $4,000+$800+$700 = $5,500

Common stock:

Outstanding: 2,000

Converted from bonds: 1,000

Converted from stock options: 1,000

Converted from preferred stock: 500

Total outstanding: 4,500

Diluted EPS: $5,500/4,500 = $1.22 per share