At Dec 31, 2009, ABC had 800,000 common shares outstanding. In addition, ABC had 300,000 preferred shares which were convertible into 500,000 common shares. During 2008, ABC paid $300,000 in cash dividends on the common shares and $200,000 in cash dividneds on the preffered shares. Net income for 2008 was $1,700,000 and income tax rate was 40 %. What is the diluted EPS. My understanding is Diluted EPS = (1,700,000 + 200,000)/(800,000+500,000) = 1.46 But the answer is 1.31? do we add dividends on common shares to N.I in the calculation.?
If you use the converted ordinary number of pref shares in the denominator, you need to deduct preferred dividends from the numerator. This is because you wouldn’t be paying divs on the prefs if they had been converted to ordinary shares. So, to get to the answer: Net income + divs on preferred - divs on preferred over Common shares + converted preference shares. (1,700,000 + 200,000 - 200,000)/(800,000 + 500,000) = $1.31.