# Is schweser's answer wrong?

Book7-1-167 Earning: \$762M; average stock price \$18. Common shares outstanding 600M; 12m shares of 7%, \$25 par value, cumulative preferred stock and 4m shares of 5%, \$100 par convertible prefered stock, each convertible into 25 common shares. 30m options outstanding, with ex price \$25 per share. Calculate diluted earning per share. A. \$1.04 B. \$1.07 C. \$1.09 D. \$1.24 I think Schweser’s answer, which is C, is WRONG. Any comment?

hmmmm i got neither answer…i got \$1.06 convertible preferred stock is dilutive…options are not… so, 762,000,000 - 0.07(25)(12,000,000) _____________________________ 600,000,000 + 100,000,000 so i’d say B?

you only have to take into account the preffereds which are convertible 4mil*25=100mil 762/700=1.088 C is the answer their earnings are net income not gross

That’s the cumulative preferred stock. not non-cumulative, whose divident we do not substract from NI. Am I right?

I got C. The only dilutive is the convertible preferred.

dont you have to decrease earnings by the dividend paid to cum. pref. stockholders? since you should only include net income thats availble to COMMON stockholders?

right… I got \$1.07, too. taking out both prf. , and adding the dilutive one back.

the point is that they ask for diluted only preferred are dilutive so you don’t do substract the dividends since you convert the preferred

Im with naivejoe and bluey here. florinpop there are two preferred stocks here 12m shares of 7%, \$25 par value, cumulative preferred stock and 4m shares of 5%, \$100 par convertible prefered stock, each convertible into 25 common shares. the first one is not dilutive so we need to subtract those dividends from the earnings.

Hi, Florinpop: I am not talking about substracting or not the dividend of potentially dilutive prf. it is not questionable that this DIV need to be included in the calculation. I am talking about what needs to be taken out from NI is the cumulative prf. When I read the answer given by Schweser, i was really shocked. they took the cumulative prf. DIV out, and add the convertible prf. DIV. finally, they got something funny like this. diluted EPS= (762-21+20)/ (600+100) I was thinking: what the hell, am I crazy or schweser is wrong!

right reema i misread i think i need sleep! thought those were bonds

naivejoe, that is the exact calculations I got. You subtract 21 for the cumulative preferred and add back 20 for the convertible prf since they are dilutive.

i think schweser is wrong… the 20 for the convertibles are taken out, then added back (as they are dilutive) so they cancel each other out…

I believe that convetible preferred is generally treated like debt so you need to add it back and subtract only the cum preferred. so basic eps = 762 - (.07 * 25 * 12) / 600 = 1.235 diluted eps = (762 -21 + 20 ) / (600 + 100 ) = 1.087

Why would u add back the preferred div when it is not taken from the NI in the first place? Cumul. PS is different than convertible PS so it makes no sense to add back PS Div right?

Not adding back the Cumulative dividends, you add back the convertible dividends since convertible dividends are considered debt. So Net income already accounts for the convertible preferred. the CFAI book had a good appendix on the calculation of eps which relaly helped me clarify this in my mind Also this seems like a useful link . Check out point 26. http://www.wku.edu/~jack.hall/fasb128.htm

Isn’t PS dividend excluded from Net income? That is why in the calculating the cost of ps, the effect of taxes does not apply.

here are my calculations: basic EPS = (762-21-20)/600 = 1.20 diluted EPS = (762-21)/600 = 1.06 I’m going with B.

maratikus I believe the denominator should be 700 – due to the conversion of the Convertible preferred stock… You have the answer right, only a typo while putting it in here.

thanks cpk123. it was a typo, i meant (600+100).