Another EPS question

Use the following information to answer Questions 58 and 59. Monan Co. has the following capital structure at the end of 2005: 6% Preferred stock, cumulative, $100 par, each share convertible into 3.3 shares of common stock, 10,000 shares issued and outstanding. Common stock, $1 par, 400,000 shares issued and outstanding 7% Bonds, each $1,000 bond convertible into 40 shares of common stock, issued at par, $2,000,000 outstanding The company also has 120,000 unexercised stock options outstanding the entire year. Each option allowed the holder to acquire one share of common stock for $2. The average market price of the company stock was $6. There were no stock transactions during the year. Net income for 2005 was $800,000 and the income tax rate was 35%. Basic earnings per share for 2005 is closest to: A. $1.40. B. $1.69. C. $1.85. D. $2.00. Diluted earnings per share for 2005 is closest to: A. $1.43. B. $1.48. C. $1.50. D. $1.59.

basic (800000 - 100*10000*.06 ) / 400000 = 1.85

basic eps: C (800 - 60) / 400 diluted eps: C all are dilutive so diluted eps = 800 + (140 * .65) ) / (400 +33 (preferred) + 80 + 80) = 1.5

C and C

Guys, i got the following answer when calculating the individual effects of prefered stock and bond’s diluted eps, 800000/ 400000+33000 = 1.8475 891000/ 400000+80000 = 1.8523 (aren’t the bonds antidilutive on its own??) Thanks in advance for your explanations.

for bonds you fogot to substract the preferred dividends

Yeah…I thought C and C as well… Actual: C & B Reasons: 1st Q: Net income 800,000 Less: Preferred stock dividend (6% x 100 x 10,000) 60,000 Net income available to common stockholders 740,000 Weighted average shares outstanding 400,000 Basic earnings per share $ 1.85 2nd Q: Incremental shares from options: 120,000 x ([6 – 2]/6) = 80,000. Per share impact of Preferred stock: (6% x $100 x 10,000)/(10,000 x 3.3) = 60,000/33,000 = $1.82. Bonds payable: (7% x $2,000,000 x [1-35%])/([2,000,000/1,000] x 40) = 91,000/80,000 = $1.14. Basic EPS + Options: (800,000 - 60,000)/(400,000 + 80,000) = 740,000/480,000 = $1.54. Basic EPS + Options + Bonds: (740,000 + 91,000)/(480,000 + 80,000) = 831,000/560,000 = $1.48 Preferred stock per share impact is $1.82, which is greater than the earnings per share calculated above with just the options and the bonds. The preferred stock is therefore antidilutive and not included in the calculation of the diluted EPS.

so in this kind of problem, which one do you account for first? When you look without the Option conversion 1.82 < 1.85… so it is dilutive when you use the options dilution effect first 1.82 > 1.54 so antidilutive.

From the AICPA guidelines: A company must calculate the incremental per share effect for each group of convertible securities. Any such security for which the effect is greater than basic EPS based on operating income is considered antidilutive and is not included in a company’s diluted EPS computation. I don’t think the answer is right chadtap… Where did the question/answer come from?

I second that kant, We don’t try all the n*(n+1)/2 combinations to see if inclusion of any of the potentially dilutive security would make the EPS go Anti-dilutive. It’s done on an Individual/ case-by-case bases, but then I would like to hear this from someone into equities for their bread-&-butter. - Dinesh S

C & C I think you don`t account anything “first”. You check for every transaction whether it is dilutive related to basic eps.