On January 2, 2014, Perez Co. issued at par $10,000 of 8% bonds convertible in total into 1,000 shares of Perez's common stock. No bonds were converted during 2014. Throughout 2014, Perez had 1,000 shares of common stock outstanding. Perez's 2014 net income was $6,000, and its income tax rate is 30%. No potentially dilutive securities other than the convertible bonds were outstanding during 2014. Perez's diluted earnings per share for 2014 would be (rounded to the nearest penny)

Question

Quizplus · Accepted Answer

To calculate diluted earnings per share, we need to see the impact of potentially dilutive securities like convertible bonds. Since there were no conversions in 2014, the bonds are not dilutive for this year. However, we need to check if any interest expense on the bonds is dilutive.

The annual interest expense on the bonds is $800 ($10,000 × 8%), and it is tax-deductible. So, the after-tax interest expense is $560 ($800 × 70%). To find the potentially dilutive shares, we need to divide the after-tax interest expense by the diluted EPS assuming full conversion (i.e. $6,000/(1,000 + 1,000)). This gives $0.28 ($560 ÷ 2,000).

Since the conversion price is $10 per share ($10,000 ÷ 1,000), the bonds are dilutive only if the average market price per share is higher than $10.28. The average market price per share is not given in the question, so we cannot verify if the bonds are dilutive.

Therefore, the diluted EPS for Perez Co. is the same as the basic EPS, which is $6,000/1,000 = $6.00 per share.