Question

Munch has $500,000 of convertible 6% preferred stock outstanding. the shares can be converted to 40,000 common shares. munch's tax rate is 40%. for purposes of determining whether the preferred shares are dilutive, the incremental effect of the preferred shares is:

a. $0.45
b. $1.33
c. $2.22
d. $0.75

Answer 1

Munch's $500k stock tango: 6% dividend sways, converts to 40k common's beat. Tax tango trims the tune, but earnings still hum. $1.33 per share, likely the rhythm that moves Munch's market heart.

Determining the dilutive effect requires comparing the earnings per share (EPS) with and without the convertible preferred shares. Here's how to calculate it:

Step 1: Calculate potential common shares from conversion.

• With 40,000 potential common shares from conversion, the total outstanding shares after conversion would be 500,000 current shares + 40,000 converted shares = 540,000 shares.

Step 2: Calculate annual dividends on preferred shares.

• Annual dividends = $500,000 preferred stock * 6% = $30,000.

Step 3: Calculate the tax effect of dividends.

• Munch's tax on dividends = $30,000 dividends * 40% tax rate = $12,000.

Step 4: Calculate incremental earnings per share with conversion.

• Assume the same amount of total earnings before and after conversion.

• Subtract the tax effect of dividends from earnings: Adjusted earnings = total earnings - $12,000 tax on dividends.
• Divide adjusted earnings by total shares after conversion: EPS with conversion = adjusted earnings / 540,000 shares.

Step 5: Calculate EPS without conversion.

• Divide total earnings by current outstanding shares: EPS without conversion = total earnings / 500,000 shares.

Step 6: Calculate the incremental effect.

• Subtract the EPS without conversion from the EPS with conversion: Incremental effect = EPS with conversion - EPS without conversion.

Note: We don't have information about total earnings, so we cannot calculate the exact answer. However, we can compare the options based on the incremental effect calculation:

• Option a) $0.45: This is too low compared to the potential dividend per share ($30,000 / 540,000 shares ≈ $0.55).
• Option b) $1.33: This is a reasonable estimate if we consider typical earnings and tax rates.
• Option c) $2.22: This is too high and unlikely based on the calculation steps.
• Option d) $0.75: This could be possible depending on the total earnings, but less likely than option b).

Therefore, the most likely answer based on the provided information is (b) $1.33.

However, remember that this is an estimation without the actual total earnings figure. For a more accurate calculation, the specific earnings value is needed.