AbC was formed on june 10, 2011, through the issuance of 2,500.000 shares of com

Question

AbC was formed on june 10, 2011, through the issuance of 2,500.000 shares of common stock to owners. The company had the following transactions during 2014,On Apil 1, 2014, the company issued an additional 30 00 shares of stock for cash On July 1 2014, ABC issued $1 million of 15 year 6% convertible bonds at par t ach $1,000 bond converts to 25 shares of common at any interest date. None of the bonds have been converted to report after tax netincome of $13,000,000 The tax rate is 40% Determine the following for 2014. (a) The number of shares to be used for calculating (1) Basic earnings per share date. ABC is preparing its annual report for the fiscal year ending December 31, 2014, and wil 2) Diluted earnings per share (b) The earnings figures to be used for cakculating 1) Basic earnings per share (2) Diluted earnings per share

Explanation / Answer

The formula for calculating EPS is:

(Total income - Preferred dividends) / Outstanding shares

The formula for calculating DEPS is:

(Total income - Preferred dividends) / (Outstanding shares + Diluted Shares)

Since there are no preferred dividends, hence that number will be zero.

a.

1. The number of shares for calculating BEPS = Outstanding shares

= 2500000 + (500000 x 9/12)

= 2875000 shares

2. The number of shares for calculating BEPS = Outstanding shares + Diluted shares

Test for dilution:

BEPS = $13600000 / 2875000 = $4.73

[Convertible Debt interest x (1 - tax rate)] / Convertible shares

= [$1000000 x 6% x 6/12 x (1 - 0.40)] / (1000000/1000 x 25 x 6/12)

= $18000/ 12500

= $1.44

Since this number is less than BEPS, the convertible bond is dilutive.

Hence such shares shall be included in the caluculation of DEPS.

Diluted shares = 1000000/1000 x 25 x 6/12 = 12500

The number of shares for calculating BEPS = Outstanding shares + Diluted shares

= 2875000 + 12500

= 2887500

b.

The earnings used for calculating BEPS and DEPS, both, will be same.

1. The earnings used for calculating BEPS = Total income after tax = $13600000

2. The earnings used for calculating DEPS = Total income after tax = $13600000

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