Karen Company had 105,000 shares of common stock outstanding on January 1, 2011.

Question

Karen Company had 105,000 shares of common stock outstanding on   January 1, 2011. On August 30, 2011, Karen sold 50,000 shares of common stock   for cash. Karen also had 11,000 shares of convertible preferred stock   outstanding throughout 2011. The preferred stock is $105 par, 5%, and is   convertible into 4 shares of common for each share of preferred. Karen also   had 400, 8%, convertible bonds outstanding throughout 2011. Each $1,000 bond   is convertible into 35 shares of common stock. The bonds sold originally at   par. Reported net income for 2011was $350,000 with a 35% tax rate. The   regular common and preferred dividends were paid in 2011.

Karen Company had 105,000 shares of common stock outstanding on   January 1, 2011. On August 30, 2011, Karen sold 50,000 shares of common stock   for cash. Karen also had 11,000 shares of convertible preferred stock   outstanding throughout 2011. The preferred stock is $105 par, 5%, and is   convertible into 4 shares of common for each share of preferred. Karen also   had 400, 8%, convertible bonds outstanding throughout 2011. Each $1,000 bond   is convertible into 35 shares of common stock. The bonds sold originally at   par. Reported net income for 2011was $350,000 with a 35% tax rate. The   regular common and preferred dividends were paid in 2011.

Compute basic and diluted earnings per share for 2011 What is meant by dilution of earnings per share? What is the

Explanation / Answer

Hi,

Please find the answer as follows:

Part A:

Earnings Available to Equity Holders = 350000 + 11000*.05*105*(1-.35) + 400*.08*(1-.35) = 350378.30

Total Number of Shares = 105000 (Common Stock Shares) + 11000*1/4 (Preferred Stock) + 400/100*35 (Convertible Bonds) = 107890

Diluted EPS = Earnings Available to Equity Holders/Total Number of Shares = 3.25 per share

Answer for Part A is 3.25 per share

Part B:

Diluted earnings per share is used to calculate a company's earnings per share with the use of income available to equity holders and fully diluted outstanding shares. This method is used if the option to convert securities (such as convertible bonds, debentures, etc.) is excercised.

Part C:

This method is used to evaluate the result of conversion of convertible securities into new shares (if they are so converted). It is essential to note that under this method only in-the-money convertible securities are considered.

Thanks.

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