Question

Please show calculations

( Tuuupicu) Ok E16.24 (LO 5) (EPS with Convertible Bonds and Preferred Stock) The Simon Corporation issued 10-year, $5,000,000 par, 7% callable convertible subordinated debentures on January 2, 2020. The bonds have a par value of $1,000, with interest payable annually. The current conversion ratio is 14:1, and in 2 years it will increase to 18:1. At the date of issue, the bonds were sold at 98. Bond discount is amortized on a straight-line basis. Simon's effective tax was 20%. Net income in 2020 was $9,500,000, and the company had 2,000,000 shares outstanding during the entire year. Instructions a. Prepare a schedule to compute both basic and diluted earnings per share. b. Discuss how the schedule would differ if the security was convertible preferred stock.

Answer 1

ANSWER:

(a)      Net income for year                                                                                                          $9,500,000

          Add: Adjustment for interest (net of tax)                                                                            234,000*

                                                                                                                                                    $9,734,000

          *Maturity value                                                                                                                 $5,000,000

            Stated rate                                                                                                                      X           7%

            Cash interest                                                                                                                        350,000

            Discount amortization [(1.00 – .98) X $5,000,000 X 1/10]                                                   10,000

            Interest expense                                                                                                                  360,000

            1 – tax rate (35%)                                                                                                           X           .65

            After-tax interest                                                                                                             $   234,000

            $5,000,000/$1,000 = 5,000 debentures

                    Increase in diluted earnings per share denominator:

                                 5,000

                            X       18

                            90,000

          Earnings per share:

                    Basic EPS                       $9,500,000 ÷ 2,000,000 = $4.75

                    Diluted EPS                    $9,734,000 ÷ 2,090,000 = $4.66

(b)      If the convertible security were preferred stock, basic EPS would be the same assuming there were no preferred dividends declared or the preferred was noncumulative. For diluted EPS, the numerator would be the net income amount and the denominator would be 2,090,000.