honeycfa

The primary difference between basic EPS and diluted EPS is that:

A) proprietors and partners report basic EPS but corporations report diluted EPS.

B) extraordinary items and discontinued operations are omitted from basic EPS but included in diluted EPS.

C) diluted EPS includes the potential effects of convertible securities while basic EPS does not.

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The primary difference between basic EPS and diluted EPS is that diluted EPS includes the potential effects of convertible securities while basic EPS does not.

honeycfa

During 2005, Advantage paid dividends of $3 per share on its preferred stock. The preferred shares are convertible into 20,000 shares of common stock. The 8% bonds are convertible into 30,000 shares of common stock. Net income for 2005 was $850,000. Assume the income tax rate is 30%.

Calculate Advantage's basic and diluted earnings per share (EPS) for 2005.

Basic EPS

Diluted EPS

A) $6.31 $5.66

B) $7.45 $6.26

C) $7.45 $5.66

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Basic EPS = net income ? pref div / wt. ave. shares of common

[850,00 ? (3 × 10,000)] / 110,000 = $7.45

Diluted EPS = [(net income ? preferred dividends) + convertible preferred dividends + (convertible debt interest)(1 ? t)] / [(weighted average shares) + (shares from conversion of conv. pfd shares) + (shares from conversion of conv. debt) + (shares issuable from stock options)]

[(850,000 ? (3 × 10,000)) + 30,000 + (80,000)(1 ? 0.3)] / [(110,000) + (20,000) + (30,000)] = $5.66.

honeycfa

Securities that would decrease earnings per share (EPS) if they were exercised and converted to common stock are called:

A) dilutive securities.

B) synthetic securities.

C) antidilutive securities.

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Dilutive securities are securities that decrease EPS if they are exercised or converted to common stock. Stock options, warrants, convertible debt, and convertible preferred stock are examples of dilutive securities.

honeycfa

Securities that improve basic per share earnings, or reduce per share losses, if they are exercised or converted to common stock are called:

A) dilutive securities.

B) antidilutive securities.

C) embedded securities.

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Antidilutive securities, upon exercise, increase basic EPS or decrease per share losses. Shares from conversion are not included in the calculation of basic or diluted EPS.

honeycfa

Which of the following statements about the earnings per share calculation are most accurate?

A) When calculating diluted EPS you must add the shares created from the conversion of the bonds to the denominator and the interest expense times the tax rate to the numerator.

B) If the diluted EPS is less than the basic EPS, then the diluted EPS is said to be anti-dilutive.

C) None of these choices are correct.

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Anti-dilutive is when dilutive EPS > basic EPS. When calculating diluted EPS, you must add the shares created from the conversion of the bonds to the denominator and the interest (1 – tax rate) to the numerator.

honeycfa

Anti-dilutive securities should:

A) be used in calculating basic EPS but not diluted EPS.

B) be used in calculating diluted EPS but not basic EPS.

C) not be used in calculating basic or diluted EPS.

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Antidilutive securities would increase EPS if exercised or converted to common stock.

honeycfa

How will dilutive securities affect earnings per share (EPS) when determining diluted earnings per share?

A) Decrease EPS.

B) Increase EPS.

C) Either decrease or increase EPS depending upon if the security is dilutive or antidilutive.

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Dilutive securities such as convertibles and options are found in a complex capital structure and always decrease EPS. Convertibles and options may also be antidilutive, which will increase EPS hence the name antidilutive. The only way to know if a security is dilutive or antidilutive is to compare the basic EPS to diluted EPS. If the diluted EPS is higher than the basic EPS then the security is antidilutive and should not be included when determining diluted EPS.

honeycfa

In calculating the numerator for diluted Earnings Per Share, the interest on convertible debt is:

A) subtracted from earnings available to common shareholders after an adjustment for taxes.

B) added to earnings available to common shareholders after an adjustment for taxes.

C) added to earnings available to common shareholders.

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Formula = Diluted EPS = [(Net income ? Preferred dividends) + Convertible preferred dividends + (Convertible debt interest)(1 ? t)] / [(Weighted average shares) + (Shares from conversion of conv. pfd shares) + (Shares from conversion of conv. debt) + (Shares issuable from stock options)]

honeycfa

An analyst has gathered the following information about Artcraft, Inc. for the year:

• Net income of $30,000.
• 5,000 shares of common stock and 500 shares of 8%, $90 par convertible preferred stock outstanding during the whole year.
• Each share of convertible preferred can be converted into 4 shares of common stock.
• Last year, Artcraft issued at par, $60,000 total face value of 6.0% convertible bonds, with each of the 60 bonds convertible into 110 shares of the Artcraft common stock.

If Artcraft's effective tax rate is 40%, what will Artcraft report as diluted earnings per share (EPS)?

A) $3.12.

B) $2.36.

C) $3.37.

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Diluted EPS = adjusted earnings after conversion (EAC) / weighted average plus potential common shares outstanding.

Step 1: Calculate Adjusted EAC

adjusted EAC:		net income - preferred dividends
	+	dividends on convertible preferred stock
	+	after-tax interest on convertible debt
	=	adjusted earnings available for common shares

preferred dividends = convertible preferred dividends = (0.08)(90)(500) = 3,600

convertible debt interest = (60,000)(0.06)(1 – 0.40) = 2,160

adjusted EAC = (30,000 – 3,600 + 3,600 + 2,160) = $32,160

Step 2: Calculate Weighted average plus potential common shares outstanding.

weighted average common shares			=	5,000
shares from conversion of convertible preferred stock	=	(500 × 4)	=	2,000
shares from conversion of convertible bonds	=	(60 × 110)	=	6,600
weighted ave. plus potential common shares outst.			=	13,600

Step 3: Calculate Diluted EPS

Diluted EPS = 32,160 / 13,600 = $2.36.

honeycfa

In calculating the numerator for diluted earnings per share, the dividends on convertible preferred stock are:

A) added to earnings available to common shareholders with an adjustment for taxes.

B) subtracted from earnings available to common shareholders without an adjustment for taxes.

C) added to earnings available to common shareholders without an adjustment for taxes.

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Diluted EPS = [(Net income ? Preferred dividends) + Convertible preferred dividends + (Convertible debt interest)(1 ? t)] / [(Weighted average shares) + (Shares from conversion of conv. pfd shares) + (Shares from conversion of conv. debt) + (Shares issuable from stock options)]