On January 2, 2011, Worley Co. issued at par $50,000 of 4 percent bonds convertible, in total, into 5,000 shares of Worley's common stock. No bonds were converted during 2011. Throughout 2011 Worley had 5,000 shares of common stock outstanding. Worley's 2011 net income was $5,000. Worley's income tax rate is 40 percent. No potentially dilutive securities other than the convertible bonds were outstanding during 2011. Worley's diluted earnings per share for 2011 would be

Question

Quizplus · Accepted Answer

First, we need to calculate the basic earnings per share (EPS) using the following formula:
Basic EPS = Net Income ÷ Weighted Average Number of Common Shares Outstanding
Weighted average number of common shares outstanding = 5,000 (given)
Basic EPS = $5,000 ÷ 5,000 = $1.00
Next, we need to calculate the potential impact of the convertible bonds on diluted EPS. Since the conversion ratio is 5,000 shares per $50,000 bond, the conversion price is $10 per share ($50,000 ÷ 5,000 shares). Since the bonds carry a 4% annual interest, the interest expense is $2,000 ($50,000 x 4%) per year. To calculate the potential impact of the bonds, we need to adjust our weighted average number of shares outstanding to include the additional shares that would be issued upon conversion of the bonds:
Number of shares upon full conversion of bonds = $50,000 ÷ $10 per share = 5,000 shares
Weighted average number of shares outstanding (diluted) = 5,000 + (2,000 ÷ $10) = 5,200
(Note: $2,000 is the interest expense divided by the conversion price of $10)
Diluted EPS = Net Income ÷ Weighted Average Number of Shares Outstanding (diluted)
Diluted EPS = $5,000 ÷ 5,200 = $0.96
Therefore, the correct answer is B) $0.62.