Diluted EPS

Org XYZ - - Earning after tax: \$850,000 - 500,000 common stock shares, par value \$10 each - Tax rate 30% - 350,000 of 8% \$10 par convertible preferred stock. Each preferred share is convertible into 2.5 shares of common stock. Calculate Diluted earnings per share.

350,000*2.5=875,000 875,000+500,000=1,375,000 850,000/1,375,000 = 0.62 diluted EPS

The answer is \$0.822 Basic EPS =850000/500,000 = 1.70 To calculate whether the preferred stocks are dilutive: (350,000 x 10 x8%)/(80,000 x 2.5) = 1.40 Since this is lower than basic EPS, there dilutive. Diluted EPS = (280,000 + 850,000)/(500,000 + 875,000) = 0.822

Lloyd, thats what I did too… but according to the answer its wrong… i am so confused now!! I thought for preferred shares we dont have a “quick” way to see if the shares are dilutive or not…!

What is the market value of the comon stock? We only have par value of the comon stock. What am I mising here?

kochunni69 Wrote: ------------------------------------------------------- > What is the market value of the comon stock? We > only have par value of the comon stock. What am I > mising here? Thats the entire question i am afraid… they didn’t state the market value of common stock

You don’t need the market value of common to calculate the diluted EPS. That would only be useful to determine if it is likely that they will be converted, not the effects of the conversion.

Is it \$1.70

Dreary Wrote: ------------------------------------------------------- > Is it \$1.70 Nah it is 0.822 The answer is \$0.822 Basic EPS =850000/500,000 = 1.70 To calculate whether the preferred stocks are dilutive: (350,000 x 10 x8%)/(80,000 x 2.5) = 1.40 Since this is lower than basic EPS, there dilutive. Diluted EPS = (280,000 + 850,000)/(500,000 + 875,000) = 0.822

you don’t add the 280,000 for the preferred divs back, because technically it is: \$850,000-\$280,000(to get NI for CS)+\$280,000(b/c conversion eliminates Pref. Divs), so you really just use the EAT divided by the #CS outstanding+#CS converted from PS

Thanks WYantjs

I’m pretty sure I’m right… the only adjustment to the numerator should be adding back on preferred dividends, leaving you with the original net income. the denominator is just original shares + (# preferred shares)*(conversion rate). you shouldn’t need market value of the common stock when its preferred stock. market value is only used in the treasury stock method, which is only used for options and warrants.

yea, I think it’s \$0.62

thanks guys i think it must be an error in the practice exam =)

basic EPS should have a numerator of 850,000-280,000. In the basic EPS formula you subtract the preferred dividends. In dilutive, you add back the same subtracted dividends, leaving you with just net income in the numerator.

yeah that’s correct, I was thinking of something else. Say they also had, 350,000 of 8% \$10 par *non convertible* preferred stock, each preferred share convertible into 2.5 shares, how would you calculate diluted EPS?

i have no idea… since its not convertible, there is no effect on the common shareholder, that would just be basic EPS

Say *instead* they had, 350,000 of 8% \$10 par *non convertible* preferred stock, each preferred share convertible into 2.5 shares, how would you calculate diluted EPS?

well if its non converitble preferred stock, the second part of your sentence doesnt really make much sense… still would be basic EPS

that’s correct…when the problem has both types of preferred, it is very common for people to make a mistake and add back preferred dividends of both types of preferred to NI. That’s what I wanted to point to.