My confusion in the question below is the treatment of preferred stock for the denominator. Why are we not adding the 2,000 shares of preferred stock outstanding to the denominator? Why only the common stock and convertible shares? Thank you!
During 20X3, Rory, Inc., reported net income of $15,000 and had 2,000 shares of common stock outstanding for the entire year. Rory also had 2,000 shares of 10%, $50 par value preferred stock outstanding during 20X3. During 20X1, Rory issued 100, $1,000 par, 6% bonds for $100,000. Each of these is convertible to 50 shares of common stock. Rory’s tax rate is 40%. Assuming these bonds are dilutive, 20X3 diluted EPS for Rory is closest to:
Common shares partake in the equity growth of the firm but preferred shares do not, therefore their shares don’t affect EPS weighted average calculation. They do however affect what gets passed along to the common shareholders because they get their preferred dividend before common shares get their share of the income. NI gets lowered by the preferred dividends but that’s the extent of their claim, the rest goes to common shares so if there’s a dilutive instrument that’ll dilute during the year then it will affect what’s left (EPS) that the existing shares will see.
Diluted EPS: Because there is no Stated line that says that those preferred Shares are convertible. If they where convertible you would add $10,000 and increase commons shares by 2000* 10 (for example 1 preffered share is convertible Into 10 common shares). Hope it helps
