Question

Shipley Corporation had net income for the year of $480,000 and a weighted average number of common shares outstanding during the period of 200,000 shares. The company has a convertible bond issue outstanding. The bonds were issued four years ago at par ($2,000,000), carry a 7% interest rate, and are convertible into 40,000 shares of common stock. The company has a 40% tax rate. Diluted earnings per share are

a. $1.65
b. $2.23.
c. $2.35.
d. $2.58.

Answer 1

To calculate diluted earnings per share (EPS) with convertible bonds, add the tax savings generated from the interest expense on the bonds to the net income and divide by the total potential number of shares.

Step-by-step explanation:

To calculate diluted earnings per share (EPS), we need to consider the impact of the convertible bonds. First, we calculate the potential new shares from the conversion: 40,000 shares.

Next, we calculate the interest expense on the convertible bonds: $2,000,000 x 7% = $140,000.

Lastly, we calculate the tax savings from the interest expense: $140,000 x 40% = $56,000.

To estimate the diluted EPS, we divide the net income ($480,000 + $56,000) by the total potential number of shares (200,000 + 40,000):

$536,000 / 240,000 = $2.23.