Question

1. Throughout 2014, H had 3,770,000 shares of common stock issued and outstanding and 100,000 shares of 6%, $50 par value convertible preferred stock issued outstanding. Each share of preferred stock can be converted into 4 shares of B’s common stock. H’s net income for 2014 was $9,420,000. During 2014 H paid $300,000 of preferred dividends. H’s income tax rate is 20%.

• During the entire year ending 12-31-14, H had 400,000 outstanding and exercisable employee stock options that were granted to employees during 2013. Each option has an exercise price of $30 per share of H common stock. During 2014, the average market price of H’s common stock was $40 per share.
• As of 12-31-14, H had $5,000,000 of 5%, 15-year convertible bonds. H issued the bonds at par during 2005. The bonds can be converted into 10,000 shares of H’s common stock.
• As of 12-31-14, H had $10,000,000 of 10%, 40-year convertible bonds. H issued the bonds at par during 1995. The bonds can be converted into 400,000 shares of H’s common stock.

What will H report as basic EPS for the year ended 12-31-14? ROUND TO NEAREST PENNY.

What will H report as diluted EPS for the year ended 12-31-14? ROUND TO NEAREST PENNY.

Answer 1

Basic EPS
= Net income attributable to equity shareholders/Avg. no. of outstanding equity shares
Computation of net income attributable to equity shareholders
Net Income	$9,420,000
Less: Tax @ 20%	($1,884,000)
Income after tax	$7,536,000
Less:
Preference share dividend	($300,000)
Net income attributable to equity shareholders	$7,236,000
Computation of Basic EPS
Net income attributable to equity shareholders	$7,236,000
Number of equity share outstanding as on 12-31-14	3,770,000
Basic EPS	$1.92
Diluted EPS
The formula for computing the diluted EPS remains the same as used for Basic EPS with the
following adjustments.
(i) The net income should be adjusted for the effects of all dilutive potential equity shares
(ii) The number of equity shares should include the equity shares which would be issued on
conversion of all dilutive potential equity shares.
Adjutments to net income
Interest on 5% 15-year converible bonds	$250,000
Interest on 10% 40-year converible bonds	$1,000,000
Total interest expense	$1,250,000
Computation of Adjusted Net Income
Net Income	$9,420,000
Add: Interest expense against convertible bonds	$1,250,000
Adjusted Net Income	$10,670,000
Less: Tax @ 20%	($2,134,000)
Income after tax	$8,536,000
Net income attributable to equity shareholders	$8,536,000
Computation of adjusted number of equity shares outstanding
Common stock issued and outstanding	3,770,000
Equity shares from conversion of convertiblep reference shares	400,000
Equity share from exercise of employee stock options	400,000
Equity shares from conversion of 5% convertible bonds	10,000
Equity shares from conversion of 10% convertible bonds	400,000
Number equity shares for diluted earnings calculation	4,980,000
Computation of Diluted EPS
Adjusted net income attributable to equity shareholders	$8,536,000
Number equity shares for diluted earnings calculation	4,980,000
Diluted EPS	$1.71
Answer
Basic EPS reported in financial statements on 12/31/14	$1.92
Diluted EPS reported in financial statements on 12/31/14	$1.71
Note :
Since employee stock options have not been excercised during the year 2014, the employee
compensation expense related to stock options ( excess of market value of equity over the price at
which the exercise option is granted) is not an expense for the year and hence, not considered in
computing the adjusted net income