I think the official answer is wrong, it should have deducted preferred dividends. Can anyone confirm?
Question:
Net Income $1m
AVG no. of common shares outstanding 100,000
Convertible preferred shares:
convertible preferred shares outstanding 2,000
dividend/share $10
each preferred share is convertible into 5 common shares
Preferred dividend: 2000*10=20000
Incremental common shares: 2000*5=10000
Bond:
convertible, $100 face value per bond, total $80,000
8% coupon
each bond convertible into 25 common shares
corporate tax rate 40%
After tax cost of interest = 0.08*80000*(1-0.4)=3840
Incremental common shares from bond: (80000/100)*25=20000
Official answer:
NI+after tax cost of interest / common shares + preferred converted + bond converted
[1m + 3840] / (100000 + preferred converted 10000 + bond converted 20000 )= 7.72
Shouldn’t it be
[1m - 20000 pref. div + 3840] / (100000 + preferred converted 10000 + bond converted 20000 )= 7.57