Question

(EPS with Convertible Bonds and Preferred Stock) On January 1, 2017, Crocker Company issued 10-year, \(2,000,000 face value, 6% bonds, at par. Each \)1,000 bond is convertible into 15 shares of Crocker common stock. Crocker’s net income in 2017 was \(300,000, and its tax rate was 40%. The company had 100,000 shares of common stock outstanding throughout 2017. None of the bonds were converted in 2017.

Instructions

(a) Compute diluted earnings per share for 2017.

(b) Compute diluted earnings per share for 2017, assuming the same facts as above, except that \)1,000,000 of 6% convertible preferred stock was issued instead of the bonds. Each $100 preferred share is convertible into 5 shares of Crocker common stock.

Short answer

(a) Diluted Earnings per share $2.86

(b) Diluted Earnings per share $2.00

Step-by-step solution

 Step 1: (a) Computation of Diluted Earnings Per Share

Net income	$300,000
Interest savings net of tax($2,000,000x 0.06) x (1-.40)	$72,000
Adjusted net income	$372,000

Issued bonds ($2000,000/1000)	2,000
Converted into 15 Shares	X 15 shares
Number of shares outstanding	30,000 shares

Net Income (A)	$372,000
Average share outstanding (100,000+30,000) (B)	130,000
Diluted Earnings Per share (A/B)	$2.86

(b) Computation of Diluted Earnings Per Share

Shares outstanding	100,000
Add: Shares assumed to be issued (($1,000,000 ÷ $100 = 10,000) x 5)	50,000
Shares outstanding adjusted for dilutive securities	150,000

Net Income for diluted EPS ($300,000- $0) (A)	$300,000
Average share outstanding(B)	150,000
Diluted Earnings Per share (A/B)	$2.00