E16-25B (EPS with Convertible Bonds and Preferred Stock) On January 1, 2014, Yel
ID: 2461438 • Letter: E
Question
E16-25B (EPS with Convertible Bonds and Preferred Stock) On January 1, 2014, Yellow Car Company issued 15-year, $50,000,000 face value, 4% bonds, at par. Each $1,000 bond is convertible into 20 shares of Yellow Car common stock. None of the bonds were converted in 2014. Yellow Car’s net income in 2014 was $8,680,000, and its tax rate was 30%. The company had 2,650,000 shares of common stock issued and outstanding throughout 2014. Instructions (a) Compute diluted earnings per share for 2014. (b) Compute diluted earnings per share for 2014, assuming the same facts as above, except that $50,000,000 of 6% convertible preferred stock was issued instead of the bonds. Each $100 preferred share is convertible into 2 shares of Yellow Car common stock.
Explanation / Answer
(a) Basic EPS = $8680000/2650000
= 3.28
Potential equity shares = $50,000,000/$1000 x 20 = 1000000
Savings in interest = $50,000,000 x 4% (1-0.30) = 1400000
Diluted EPS = 8680000 + 1400000/3650000 = 2.76
(b) Basic EPS = (8680000 - $50,000,000x6%)/2650000
= 2.14
Potential equity shares = $50,000,000/$100 x 2 = 10,00,000
Dividend = $50,000,000 x 6% = 3000000
Diluted EPS = (5680000 + 3000000)/3650000
= 2.37
Since Diluted EPS becomes more than Basic EPS , preffered stock is anti dilutive. Therefore dilutive EPS will remain equals to Basic EPS i.e. 2.14
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