Diluted EPS

CFA Level I
#1

Can someone take a look at this?

Isn’t preferred dividends supposed to be included in the formula for diluted EPS after conversion as well?

Zichron, Inc., had the following equity accounts on December 31:

  • Common stock: 20,000 shares.
  • Preferred stock A: 10,000 shares convertible into common on a 2 for 1 basis, dividend of $40,000 was declared during the year.
  • Preferred stock B: 10,000 shares, convertible to common on a 4 for 1 basis, dividend of $5,000 was declared during the year.
  • The company reported net income of $120,000 and paid a $20,000 dividend to its common shareholders.

Diluted earnings per share for the year are:

#2

I wrote an article on EPS that may be of some help here: http://financialexamhelp123.com/earnings-per-share-eps/

#3

Thanks, but I still can’t figure this one out. I think what I am confused here is how to treat the preferred stock here in the question.

Is it considered the “preferred dividends” in the basic EPS formula or the “convertible preferred dividends” in diluted EPS formula?

In my thinking, since it says “convertible” in both, I would think this is not included in basic EPS but only in diluted EPS. But the answer seems to be the opposite of my thinking. What am I missing here?

For yor reference: answers below.

Basic EPS = ($120,000 − $40,000 − $5,000) / 20,000 = $3.75.

Convertible preferred stock A: $40,000 / 2(10,000) = $2.00, which is less than basic EPS so the convertible preferred stock is dilutive.

Convertible preferred stock B: $5,000 / 4($10,000) = $0.125, which is less than basic EPS so the convertible preferred stock is dilutive.

Diluted EPS = $120,000 / [20,000 + 2(10,000) + 4(10,000)] = $1.50.

#4

It is considered as just Preferred Dividend in the Basic EPS calculation, and thus subtracted from the Net Income. = ($120,000 - $40,000 - $5,000) = $75,000 in the nominator

For the Diluted EPS, remember, you will have to add back the Preferred Share Dividend back to the nominator to get 120,000… i.e., ($120,000 - $40,000 + $40,000 - $5,000 + $5,000) = $120,000.