Answer :
(1)
Basic EPS or Simple EPS = NEt income earned - preferred dividend / weighted average number of shares outstanding
YR7 Net income $1,200,000
Common stock @10 par value $6,000,000
No.of shares = $6,000,000/10 = 600,000 shares
YR6 50000 shares in common stock at the end of year 6 = 550,000 shares
Basis EPS = $1200,000 - 0 / 550,000 = $2.18
(2). Marginal effect on each potential dilutive
Weighted average number of shares are outstanding as follows if bonds and preferred shares converted into equity
# | Bond or sl cost | Shares | No of Bonds | |
Current outstanding shares | 5,50,000 | - | - | - |
8% Convertible bonds | 80,000 | 1 1000 | 40 | $2000,000/1000 = 2000 |
7% Covrtible bonds | 22,500 | 1 1000 | 15 | $1500,000/1000 = 1500 |
6% Convertible preferred stock | 90,000 | 1 100 | 3 | $3000,000/100 = 3000 |
Weighted average number of shares for dilutive securities | 7,42,500 | - | - | - |
Calculation of interest on bonds
8% interest on convertible bonds of value $2,000,000 = $160,000 | 1,60,000 | $160,000 x(1-40%) |
7% Interest on convertible bonds of value $1500,000 = $105,000 | 1,05,000 | $105,000 x (1-40%) |
Total | 2,65,000 | - |
Tax Rate is 40% what saved when interest expended | 1,06,000 | - |
Total addition to the income | 1,59,000 | - |
Marginal Effect when 8% convertible bonds are converted into common stock
Income increase by $160,000 x (1- 0.40) = $96,000
Number of common stock is increase by 80000
Diluted EPS = ($1200,000 + $96,000) / (550000 + 80000) = 2.05
Marginal effect when 7% convertible bonds are converted into common stock
Income increase by $105,000 x (1-0.40) = $63,000
Number of common stock is increase by 22500
Diluted EPS = ($1200,000 + $63,000)/(550000 + 22500) = $2.21
Marginal effect when preferred shares are converted to common stock
No effect on net income
Number of common stock is increase by 90000
Diluted EPS = ($1200,000) / (550000 + 90000) = $1.88
Status | Common stock | EPS | Me Effect |
Common stock | 550000 | 2.18 | - |
8% Bond converted | 630000 | $2.05 | $0.13 |
7% Bond converted | 652500 | $2.21 | -$0.03 |
Prefered converted | 640000 | $1.88 | $0.30 |
(3).
# | Bond or sl cost | Shares | No of Bonds | |
Current outstanding shares | 5,50,000 | - | - | - |
8% Convertible bonds | 80,000 | 1 1000 | 40 | $2000,000/1000 = 2000 |
7% Covrtible bonds | 22,500 | 1 1000 | 15 | $1500,000/1000 = 1500 |
6% Convertible preferred stock | 90,000 | 1 100 | 3 | $3000,000/100 = 3000 |
Weighted average number of shares for dilutive securities | 7,42,500 | - | - | - |
Calculation of interest on bonds
8% Interest on convertible bonds of value $2,000,000 | 1,60,000 | $160,000 x (1-40%) |
7% Interest on convertible bonds of value $1500,000 | 1,05,000 | $105,000 x (1-40%) |
Total | 2,65,000 | - |
Tax Rate is 40% what saved when interest expensed | 1,06,000 | - |
Total additonal to the income | 1,59,000 | - |
Dilute EPS = $1200,000 + $159,000 / 742,500 = $1.83
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