ExpertHard1 markMultiple Choice
CPA · Question 8 · Area 1: Financial Reporting
Alpha Corp. has the following capital structure during Year 1:<br/>- Net Income: $800,000<br/>- Weighted Average Common Shares Outstanding: 100,000<br/>- 5,000 shares of 6% Cumulative Preferred Stock, $100 par, convertible into 20,000 common shares. No dividends were declared.<br/>- $1,000,000 of 4% Convertible Bonds, convertible into 30,000 common shares.<br/><br/>Tax rate is 25%. What is Diluted Earnings Per Share (EPS)?
Alpha Corp. has the following capital structure during Year 1:<br/>- Net Income: $800,000<br/>- Weighted Average Common Shares Outstanding: 100,000<br/>- 5,000 shares of 6% Cumulative Preferred Stock, $100 par, convertible into 20,000 common shares. No dividends were declared.<br/>- $1,000,000 of 4% Convertible Bonds, convertible into 30,000 common shares.<br/><br/>Tax rate is 25%. What is Diluted Earnings Per Share (EPS)?
Answer options:
A.
$5.33
B.
$5.53
C.
$5.67
D.
$7.70
How to approach this question
1. Calculate Basic EPS (NI - Pref Div) / WACSO. Note: Cumulative Pref Divs are subtracted even if not declared. 2. Calculate 'If-Converted' effects for each security. 3. Rank from most dilutive to least. 4. Add to numerator/denominator cumulatively to find Diluted EPS.
Full Answer
B.$5.53✓ Correct
B
Numerator: $800,000 (NI) - $30,000 (Pref Div) + $30,000 (Pref Div added back) + $30,000 (Interest $40k * 0.75) = $830,000. Denominator: 100,000 + 20,000 (Pref) + 30,000 (Bonds) = 150,000. Diluted EPS = $830,000 / 150,000 = $5.53.
Common mistakes
Forgetting to tax-effect the bond interest add-back; forgetting to subtract cumulative preferred dividends for Basic EPS when not declared.
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