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

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

Which of the following statements regarding basic and diluted earnings per share (EPS) is most accurate?

A) Neither basic nor diluted EPS considers antidilutive securities in its computation.

B) To calculate diluted EPS, use net income less preferred dividends in the numerator.

C) If diluted EPS is less than basic EPS then the convertible securities are said to be antidilutive.

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To calculate diluted EPS, dividends on convertible preferred stock and the after tax interest on convertible debt need to be added to net income in the numerator. If diluted EPS are more than basic EPS, the convertible securities are antidilutive and should NOT be used in computing diluted EPS.

honeycfa

Which of the following statements regarding basic and diluted EPS is least accurate?

A) A simple capital structure contains no potentially dilutive securities.

B) Dilutive securities decrease EPS if they are exercised or converted to common stock.

C) Antidilutive securities decrease EPS if they are exercised or converted.

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

honeycfa

Orange Company’s net income for 2004 was $7,600,000 with 2,000,000 shares outstanding. The average share price in 2004 was $55. Orange had 10,000 shares of eight percent $1,000 par value convertible preferred stock outstanding since 2003. Each preferred share was convertible into 20 shares of common stock. Orange Company’s diluted earnings per share (Diluted EPS) for 2004 is closest to:

A) $3.80.

B) $3.45.

C) $3.40.

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Orange’s basic EPS ((net income – preferred dividends) / weighted average common shares outstanding) is ((($7,600,000 ? (10,000 × $1,000 *times; 0.08)) / 2,000,000 =) $3.40. To check for dilution, EPS is calculated under the assumption that the convertible preferred shares are converted into common shares at the beginning of the year. The preferred dividends paid are added back to the numerator of the Diluted EPS equation, and the additional common shares are added to the denominator of the equation. Orange’s if-converted EPS is ($7,600,000 / (2,000,000 + 200,000) =) $3.45. Because if-converted EPS is higher than basic EPS, the preferred stock is antidilutive and no adjustment is made to basic EPS.