Question

On January 1, 2017, Vaughn Company issued 10-year, $2,020,000 face value, 6% bonds, at par. Each $1,000 bond is convertible into 14 shares of Vaughn common stock. Vaughn’s net income in 2017 was $326,000, and its tax rate was 40%. The company had 101,000 shares of common stock outstanding throughout 2017. None of the bonds were converted in 2017. (a) Compute diluted earnings per share for 2017. Compute diluted earnings per share for 2017, assuming the same facts as above, except that $1,010,000 of 6% convertible preferred stock was issued instead of the bonds.

A. $3.22; $3.61
B. $3.50; $3.90
C. $2.80; $3.30
D. $2.90; $3.40

Answer 1

To compute diluted earnings per share for 2017, we need to consider the impact of convertible bonds and convertible preferred stock. For the bonds, calculate diluted EPS by dividing net income minus tax savings by the weighted average number of shares. For the preferred stock, calculate additional shares and subtract them from the weighted average number of shares, then calculate diluted EPS using net income minus tax savings divided by the adjusted weighted average number of shares.

Step-by-step explanation:

To compute diluted earnings per share for 2017, we need to consider the impact of convertible bonds and convertible preferred stock.

1. For the bonds: Since none of the bonds were converted, we can calculate the diluted earnings per share by dividing the net income (326,000) minus the tax savings (326,000*0.40 = 130,400) by the weighted average number of shares outstanding.
2. For the preferred stock: We need to calculate the additional shares that would be issued if the preferred stock were converted. This is done by dividing the face value of the preferred stock (1,010,000) by the conversion price (1,000). Then, we subtract the number of shares that would be issued from the weighted average number of shares outstanding and calculate the diluted earnings per share using net income minus tax savings divided by the adjusted weighted average number of shares.

The answer is B. 3.50; 3.90.