On January 1, 2014, Crocker Company issued 10-year, $3,847,000 face value, 6% bo

Question

On January 1, 2014, Crocker Company issued 10-year, $3,847,000 face value, 6% bonds, at par. Each $1,000 bond is convertible into 22 shares of Crocker common stock. Crocker’s net income in 2014 was $298,000, and its tax rate was 45%. The company had 107,000 shares of common stock outstanding throughout 2014. None of the bonds were converted in 2014.

(a) Compute diluted earnings per share for 2014. (Round answer to 2 decimal places, e.g. $2.55.)

(b) Compute diluted earnings per share for 2014, assuming the same facts as above, except that $1,070,000 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.)

Someone previously answered (b) as $1.69 but this answer is incorrect.

Explanation / Answer

Solution:

(a)

Diluted Earnings Per Share = Potential Income / Potential No. of shares of common stock

Potential No. of shares of common stock outstanding = Common Stock shares outstanding at the end of 2014 + Convertible Debenture into shares

= 107,000 + ($3,847,000 / $1,000 x 22 shares)

= 107,000 + 84,634 = 191,634 Shares

Since, after conversion, company will not will liable to pay interest on bonds, hence net income of company will increase by interest on bonds after deducting tax benefit from that.

Potential adjusted Net Income = Net Income of year 2014 + Interest on bonds (1 – Tax Rate)

= $298,000 + [$3,847,000 x 6% x (1 – 0.45)]

= $298,000 + $126,951

= $424,951

Diluted Earnings Per Share = $424,951 / 191,634 shares = $2.217 or $2.22

(b)

In case preferred stock, company is liable to pay preferred dividend to preference shareholders. Since we need to calculate diluted earnings per share, there is no need to deduct preferred stock dividend from net income.

Hence,

The adjusted Net Income available to common stockholders after giving effect of conversion = $298,000

Potential No. of Shares outstanding = Common Stock shares outstanding at the end of 2014 + Convertible Preferred Stock into common shares

= 107,000 + ($1,070,000 / $100 x 10 shares)

= 107,000 + 107,000

= 214,000 Shares

Diluted Earnings Per Share = $298,000 / 214,000 Shares = $1.39

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