Question

Manchester Corporation had 100,000 shares of common stock outstanding and 5% bonds with a face value of $1,000,000 outstanding throughout the current year. The bonds are convertible into 150,000 common shares. Net income for the current year was $212,500 with a 25% tax rate. What is the amount of the diluted EPS for the current year

Answer 1

The diluted EPS for the current year is $1 per share.

Step-by-step explanation:

Diluted EPS is a measure to calculate the earnings per share of a company taking into account the scenario that all the options and securities that are covertible into common stock are exercised and converted.

If the bonds are converted into common shares, the interest on bond, which is deductible before tax and calculation of net income, will be added to the net income and will be adjusted for cash as there will be no debt and no interest on debt. Instead this will be a part of normal earnings of the company.

The formula for Diluted EPS is,

Diluted EPS = Net Income adjusted for interest after tax / New number of weighted average of common shares outstanding

The interest on debt was = 1000000 * 0.05 = 50000

The after tax interest is = 50000 * (1-0.25) = $37500

The new net income = 212500 + 37500 = $250000

The new number of common shares = 100000 + 150000 = 250000 shares

Diluted EPS = $250000 / 250000 shares = $1 per share.