The Fischer Company had net income of $1,500,000. Fischer paid preferred dividends of $5 on each of the 100,000 preferred shares. There are 1 million Fischer common shares outstanding. In addition to the common and preferred stock, Fischer has $25 million of 4% bonds outstanding. The face value of each bond is $1,000. Each bond is convertible into 40 common shares. If Fischer’s tax rate is 40%, determine its basic and diluted earnings per share (EPS)?
I need help calculating diluted EPS. Thanks in advance.
Firstly, you need to calculate the basic EPS to comparing whether the convertible bond is anti-diluted or diluted
Basic EPS = (NI- dividend for preferred shared)/(Average Common Share) =( $1,500,000-$5*100,000 )/1,000,000 = $1/ CS
Secondly, using “If-covered” method for convertible bond, ( I assumed that the company doesn’t have the complex capital structure like the option, warranty…):
If the bond was converted => interest expense*(1- Tax rate)/ (amount of common share can be converted from bond) = (4%* $25 million)*(1-40%)/(25,000*40) = 0.6 < basic EPS =1 => so we can conclude that the convertible bond will make EPS be diluted
Lastly calculate the Diluted EPS:
Diluted EPS = ( NI - Dividend for EPS + Interest * (1-Tax rate)/ ( Average Common Share + amount of common share can be converted from bond) = ($1,500,000-$5*100,000 + 4%* $25 million)*(1-40%) ) / ( 25,000*40 + 1,000,000) = $0.8 / share
So when the convertible bonds are converted to Common share, the EPS will decline from $1 / share to $0.8/ share