Diluted EPS - easy question

Orange Companys net income for 2004 was $7,600,000 with 2,000,000 shares outstanding. The average share price in 2004 was $55. Orange had 10,000 shares of eight percent $1,000 par value convertible preferred stock outstanding since 2003. Each preferred share was convertible into 20 shares of common stock. Orange Companys diluted earnings per share (Diluted EPS) for 2004 is closest to: A) $3.40. B) $3.45. C) $3.80. D) $3.25.

C 10,000 preferred shares x (1000 x .08) = 800,000 extra income 10,000 x 20 = 200000 extra shares 8.4M/2.2M = 3.81

Answer is ‘A’

First calculate the basic EPS: (7.6M-8%*1000*10,000)/2M=3.4 Check if the conversion of preferred is dilutive: 7.6M/(2M+10,000*20)=3.45> basic of 3.4, therefore not dilutive, the diluted EPS is equal with the basic EPS of 3.4, answer should be A.

So in any question asking to calculate diluted EPS, we would have to calculate basic EPS first to check whether the security is dilutive or not? sure makes the question longer!

Yes, you do have to calculate the basic EPS (as a precaution).

oops… note to self, review this section…

I thought you added back convertible preferred dividends when calculating the numerator? Because if the shares were converted the dividends would not have been paid?

newsuper basic EPS = NI - Pref Divs / WACSO Diluted EPS = NI (adjusted for dilution effect) - Pref Divs (adjusted for dilution effect) / WACSO (adjusted for dilution effect) In this example, you don’t add the preferreds to NI. You just don’t subtract them (because you’re not paying them if converted).

Oh yeah, I see. Only if they had given you a figure for income after dividends would you add it back? thanks

you could have a bunch of preferred dividends (the non-convertible kind) (NCPD) and then the Convertible Preferred Dividends(CPD) Basic EPS = (NI - NCPD - CPD ) / WASO Diluted EPS = (NI - NCPD) / (WASO + Converted Shares due to the preferred). If Diluted < Basic --> then use the Diluted #.