Question

At December 31, 2010, Tatum Company had 2,000,000 shares of common stock outstanding. On January 1, 2011, Tatum issued 500,000 shares of preferred stock which were convertible into 1,000,000 shares of common stock. During 2011, Tatum declared and paid $1,500,000 cash dividends on the common stock and $500,000 cash dividends on the preferred stock. Net income for the year ended December 31, 2011, was $5,000,000. Assuming an income tax rate of 30%, what should be diluted earnings per share for the year ended December 31, 2011? (Round to the nearest penny.)

a. $1.50
b. $1.67
c. $2.50
d. $2.08

Answer 1

To calculate diluted earnings per share, we need to consider the conversion of preferred stock into common stock and adjust the net income and number of shares accordingly. In this case, diluted earnings per share for the year ended December 31, 2011, would be $1.50.

Step-by-step explanation:

In order to calculate diluted earnings per share (EPS), we need to consider the conversion of preferred stock into common stock. Tatum Company had 2,000,000 shares of common stock outstanding at the end of 2010. On January 1, 2011, Tatum issued 500,000 shares of preferred stock which were convertible into 1,000,000 shares of common stock. This means that if all preferred stock is converted, the number of common shares will increase by 1,000,000.

To calculate diluted EPS, we start with the net income of $5,000,000 and subtract the preferred stock dividends of $500,000. The resulting amount is the numerator for diluted EPS.

The denominator for diluted EPS is the sum of the outstanding common shares and the additional shares that would be created if all preferred stock is converted. In this case, the denominator would be 2,000,000 (outstanding common shares) + 1,000,000 (additional shares from preferred stock conversion), which equals 3,000,000 shares.

Finally, we can calculate diluted EPS by dividing the adjusted net income by the adjusted number of shares: $4,500,000 (net income - preferred stock dividends) / 3,000,000 (outstanding common shares + additional shares from preferred stock conversion) = $1.50 per share.