On January 1, 2014, Crocker Company issued 10-year, $3,249,000 face value, 6% bo

Question

On January 1, 2014, Crocker Company issued 10-year, $3,249,000 face value, 6% bonds, at par. Each $1,000 bond is convertible into 19 shares of Crocker common stock. Crocker's net income in 2014 was $329,000, and its tax rate was 45%. The company had 101,000 shares of common stock outstanding throughout 2014. None of the bonds were converted in 2014. Compute diluted earnings per share for 2014. (Round answer to 2 decimal places, e.g. $2.55.) Compute diluted earnings per share for 2014, assuming the same facts as above, except that $1,010,000 of 6% convertible preferred stock was issued instead of the bonds. Each $100 preferred share is convertible into 10 shares of Crocker common stock. (Round answer to 2 decimal places, e.g. $2.55.)

Explanation / Answer

(a)

While calculating the diluted earnings per share (EPS), it is assumed that every security which is convertible to common stock is converted. It is irrelevant whether it is actually converted or not.

If convertible bonds are converted to common stock, the interest on such bonds would not have been paid.

Earnings for diluted EPS = Net income + After-tax interest on bonds

After tax interest on bonds = $3,249,000 * 6% * (1-0.45) = $107,217

Earnings for diluted EPS = $329,000 + $107,217 = $436,217

Each $1,000 bond is convertible to 19 shares of common stock

No. of shares issued on conversion of bonds = ($3,249,000/$1000) * 19 = 61,731

Outstanding shares for diluted EPS = 101,000 + 61,731 = 162,731

Diluted earnings per share = $436,217 / 162,731 = $2.68 per share

(b)

Since preferred stock holders are not paid any interest, no modification is required to be made in net income.

Each $100 preferred share is convertible to 10 shares of common stock

No. of share issued on conversion of preferred share = ($1,010,000/$100)*10 = $101,000

Diluted earnings per share = $101,000 / 101,000 = $1 per share

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