Answer:
1) Calculation of Basic EPS
Basic EPS = (Net Income - Preferred Dividend) / weighted average number of shares outstanding
= ($5,00,000 - 6% x $1,00,000) / 1,25,000
= ($5,00,000 - $6,000) / 1,25,000
= $4,94,000/1,25,000
Basic EPS = $3.95 per Share
2) Calculation of Diluted EPS
If Incremental EPS < Basic EPS = Potentially Dilutive
If Incremental EPS > Basic EPS = Anti-dilutive
Calculation of Incremental EPS
a) Stock Options:
Income Effect = $0
Share Effect = N(1-X/S) x Fraction of Year
where,
N = Shares Issued
S = Average Stock Price during Year
X = Exercise Price
Share Effect = 12000(1-$7.50/$9) x 1
= 2000
Incremental EPS = Income Effect / Share Effect
= $0/2000
Incremental EPS = $0 < Basic EPS = $3.95 Stock Optiions are Potentially Dilutive
b) Convertible Preffered Stock :
Income Effect = Preferred Dividends x Fraction of Year
= $6000 x 1
Income Effect = $6000
Share Effect = Shares Outstanding to be Issued x Fraction of Year
= ($1,00,000/$10) x 1.5 x 1
Share Effect = 15000 shares
Incremental EPS = $6000/15000
Incremental EPS = $0.40 < Basic EPS = $3.95 Convertible Preffered Stock are Potentially Dilutive
c) 8% Convertible Bonds :
Income Effect = (1-Tax Rate) x Interest Expense x Fraction of Year
= (1 - 34%) x 8% x $1,00,000 x 1
= $5280
Share Effect = Shares Outstanding to be Issued x Fraction of Year
= ($1,00,000/$1,000) x 90 x 1
= 9000 Shares
Incremental EPS = $5280/9000
Incremental EPS = $0.59 < Basic EPS = $3.95 8% Convertible Bonds are Potentially Dilutive
d) 13% Convertible Bonds :
Income Effect = (1-Tax Rate) x Interest Expense x Fraction of Year
= (1 - 34%) x 13% x $30,000 x 1
= $2574
Share Effect = Shares Outstanding to be Issued x Fraction of Year
= ($30,000/$1,000) x 30 x 1
= 900 Shares
Incremental EPS = $2574/900
Incremental EPS = $2.86 < Basic EPS = $3.95 13% Convertible Bonds are Potentially Dilutive
d) 7% Convertible Bonds :
Income Effect = (1-Tax Rate) x Interest Expense x Fraction of Year
= (1 - 34%) x 7% x $60,000 x 1
= $2772
Share Effect = Shares Outstanding to be Issued x Fraction of Year
= ($60,000/$1,000) x 20 x 1
= 1200 Shares
Incremental EPS = $2772/1200
Incremental EPS = $2.31 < Basic EPS = $3.95 7% Convertible Bonds are Potentially Dilutive
d) 11% Convertible Bonds :
Income Effect = (1-Tax Rate) x Interest Expense x Fraction of Year
= (1 - 34%) x 11% x $5,00,000 x 1
= $36300
Share Effect = Shares Outstanding to be Issued x Fraction of Year
= ($5,00,000/$1,000) x 20 x 1
= 10,000 Shares
Incremental EPS = $36300/10,000
Incremental EPS = $3.63 < Basic EPS = $3.95 11% Convertible Bonds are Potentially Dilutive
Rank: Give rank in ascending order on the basis incremental EPS.
1) Stock Options
2) Convertible Preffered Stock
3) 8% Convertible Bonds
4) 7% Convertible Bonds
5) 13% Convertible Bonds
6) 11% Convertible Bonds
Calculation of Diluted EPS
Particular | Income Effect | Shhare Effect | Incremental EPS | Diluted EPS | |
Basic Eps | 494000 | 125000 | 3.95 | ||
Add: | Stock Options | 0 | 2000 | $0<$3.95 | Dilutive |
494000 | 127000 | 3.89 | |||
Add: | Convertible Preffered Stock | 6000 | 15000 | $0.4<$3.89 | Dilutive |
500000 | 142000 | 3.52 | |||
Add: | 8% Convertible Bonds | 5280 | 9000 | $0.59<$3.52 | Dilutive |
505280 | 151000 | 3.35 | |||
Add: | 7% Convertible Bonds | 2772 | 1200 | $2.31<$3.35 | Dilutive |
508052 | 152200 | 3.34 | |||
Add: | 13% Convertible Bonds | 2574 | 900 | $2.86<$3.34 | Dilutive |
510626 | 153100 | 3.34 | |||
Add: | 8% Convertible Bonds | 36300 | 10000 | $3.63>$3.34 | Anti Dilutive |
So, Diluted EPS = $3.34
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