Question

Given the following financial structure for Company S for all of 2016:

Common stock, $1 par value, 800,000 shares issued and outstanding all year.
Convertible preferred stock, 50,000 shares, $100 par value, 6% cumulative dividend, each share convertible into 5 shares of common stock.
Convertible bonds, $500,000 face value, 8% stated rate, each $1,000 bond is convertible into 20 shares of common stock.
Stock options, 100,000 options outstanding, each option convertible for one share of stock at an option price of $60 per share.
Additional information:
1. The convertible bonds were issued at par in 2015.
2. The average market price per share for the common stock was $80 for the year.
3. The income tax rate for Company S is 30 percent.
4. Net income for Company S for 2016 was $$2,600,000.
A. Calculate Basic EPS (carry calculations to 2 decimal places).
B. Show your calculations for the numerator and denominator effect of each of the above convertible securities.
C. From your calculations in Part B, complete the schedule to calculate the dilution index of each convertible security, then indicate the ranking (most dilutive = 1) of each convertible security.
D. Using the indexes above to incrementally evaluate the dilutive effect, calculate diluted earnings per share in the space provided on the answer sheet. Show the DEPS calculation at each incremental stage, and carry the calculation to 2 decimal places. CIRCLE the DEPS number that would be displayed in the financials.

Answer 1

Step-by-step explanation:

A.)

The Basic EPS can be determined by using the formula:

`\mathtt{Basic \ EPS = \frac{Net \ income \ attributabe \ to\ common \ stock \ holders }{\text{common stock outstanding throughout the year}} }`

`\text{Given Net income = \$2,600,000}`

`\text{Net income available for common stock holders = }`
`\text{ Net income given less dividend}`

`\text{ to preferred holders of stock}`

`\mathtt{=$2,600,000 - $100 * 50000* 6\%}`

`=\$2,300,000`

`\text{Common stock} = $800,000`

∴

`\mathbf{Basic \ EPS = (\$2,300,000)/(800,000) }`

`\mathbf{Basic \ EPS = \$2.88 \ per \ common \ stock}`

B.)

The calculations for the numerator and denominator effect are:

`\text{Calculation of the effect on incremental EPS}`

Convertible on preferred stock
`\mathtt{=(500,000 * 100 * 6\%)/(50000* 5)}`

`=1.20`

Convertible Bond
`=(500,000 * 8\%* 70\%)/((500,000)/(1000* 20))`

= 2.80

Stock options
`= (0)/(100,000- (100,000* (60)/(80)))`

= 0

Determination of the numerator & denominator effect for each convertible securities shown above are:

Numerator (N) Denominator (D) Dilution index = N/D

Net income $2,600,000

Less: Preferred $300000

Dividend

Common stock A

Net income $2,300,000 800,000 2.875

Add: Stock

Options (B) 0 25000

Total (C) = (A + B) $2300000 825000 2.788

Add: Convertible

Bonds (D) 428000 10000

Total (E) = (C+D) $2328000 835000 2.787

Add: Convertible

Preferred Stock (F) $300000 250000

Total (E) + (F) $2628000 1085000 2.422

C.)

Particulars Dilutive Index Rank (most dilutive is 1.)

Stock Option 2.788 1

Convertible Bonds 2.787 3

Preferred Stock 2.422 2

D.)

From above, the convertibles are diluted EPS (DEPS)

`\text{ DEPS =Net income available common stockholders + net tax dividend on convertible securities}`÷
`\text{weighted average no. of common shares + effect of convertible stock + convertible stock options}`

`\text{DEPS (1{st} stage) for only common stock}= (2300000)/(800000) = \$2.88}`

`\text{DEPS (2{st} stage)with \ stock \ options}= (2300000+0)/(800000+25000) = \$2.788}`

`\text{DEPS (3{st} stage)with \ stock \ options \& preferred \ stock }= (2300000+300000+0)/(800000+250000+25000) = \$2.42}`