Canada Corp.A firm has $10 million of outstanding convertible bonds. The coupon on these convertibles is $100 per bond, and each bond is convertible into common stock at a conversion price of $25.The income statement of the firm before conversion is as follows and EBIT remains at $6 million after conversion. Assume the firm originally paid $2 million in interest on other outstanding debt before the convertible was issued. $\begin{array}{|l|c|}
\hline & \text { Millions of Dollars before Conversion } \
\hline \text { EBIT } & 6.0 \
\hline \text { Interest } @ 10 \% & -3.0 \
\hline \text { Earnings before taxes (EBT) } & 3.0 \
\hline \text { Taxes @40\% } & -1.2 \
\hline \text { Earnings after taxes (EAT) } & 1.8 \
\hline &\
\hline \text { Shares outstanding (millions) } & 1.0 \
\hline \text { Earnings per share (EPS) } & \$ 1.80\
\hline
\end{array}$
-Refer to Scenario: Canada Corp.How much is the firm's total earnings after conversion?

Question

Canada Corp.A firm has $10 million of outstanding convertible bonds. The coupon on these convertibles is $100 per bond, and each bond is convertible into common stock at a conversion price of $25.The income statement of the firm before conversion is as follows and EBIT remains at $6 million after conversion. Assume the firm originally paid $2 million in interest on other outstanding debt before the convertible was issued. $\begin{array}{|l|c|}
\hline & \text { Millions of Dollars before Conversion } \
\hline \text { EBIT } & 6.0 \
\hline \text { Interest } @ 10 \% & -3.0 \
\hline \text { Earnings before taxes (EBT) } & 3.0 \
\hline \text { Taxes @40\% } & -1.2 \
\hline \text { Earnings after taxes (EAT) } & 1.8 \
\hline &\
\hline \text { Shares outstanding (millions) } &  1.0  \
\hline \text { Earnings per share (EPS) } &  \$ 1.80\
\hline
\end{array}$
-Refer to Scenario: Canada Corp.How much is the firm's total earnings after conversion?

Quizplus · Accepted Answer

After conversion, each bondholder will receive 40 shares of common stock because 1,000 ÷ 25 = 40. The total number of new shares issued is $10,000,000 ÷ $25 = 400,000. So, 400,000 x 40 = 16,000,000 additional shares are issued.

The new number of shares outstanding is 1,000,000 + 16,000,000 = 17,000,000. Therefore, the new EPS will be:

EPS = EAT / number of shares outstanding 
EPS = 1.8 million / 17 million shares = $0.106 per share

The total earnings of the firm after conversion will be:

Total earnings = EPS x number of shares outstanding 
Total earnings = $0.106 x 17 million shares = $1.802 million

Therefore, the firm's total earnings after conversion are $1.802 million, which is closest to option C ($2.4 million).

Canada Corp -Refer to Scenario: Canada Corp