Information concerning the capital structure of Shelmardine Corporation follows During 2017, Shelmardine paid dividends of $1.00 per common share and $2.50 per preferred share.The preferred shares are non-cumulative, and convertible into 20,000 common shares.The 9% convertible bonds are convertible into 50,000 common shares.Net income for calendar 2017 was $500,000.Assume the income tax rate is 30%.
What is the diluted earnings per share for 2017?

Question

Information concerning the capital structure of Shelmardine Corporation follows  During 2017, Shelmardine paid dividends of $1.00 per common share and $2.50 per preferred share.The preferred shares are non-cumulative, and convertible into 20,000 common shares.The 9% convertible bonds are convertible into 50,000 common shares.Net income for calendar 2017 was $500,000.Assume the income tax rate is 30%.
What is the diluted earnings per share for 2017?

Quizplus · Accepted Answer

First, we need to calculate the weighted average number of common shares outstanding:

Common shares outstanding at the beginning of the year = 200,000
Common shares issued from preferred share conversion = 20,000
Common shares issued from convertible bond conversion = 50,000

Weighted average number of common shares outstanding = (200,000 x 12) + (20,000 x 6) + (50,000 x 6)/12 + 6 + 6 = 224,167

Next, we need to calculate the net income available to common shareholders:

Net income = $500,000 x (1 - 0.30) = $350,000

Net income available to common shareholders = $350,000 - ($2.50 x 20,000) = $300,000

Finally, we can calculate the diluted earnings per share:

Diluted earnings per share = (Net income available to common shareholders + Preferred dividends) / Weighted average number of common shares outstanding

Preferred dividends = ($2.50 x 20,000) = $50,000

Diluted earnings per share = ($300,000 + $50,000) / 224,167 = $1.68

However, we need to consider the effect of the convertible bond conversion. The 9% convertible bonds could be converted into 50,000 common shares, which would reduce the interest expense and increase the net income available to common shareholders.

If the bonds were converted, the interest expense saved would be:

Interest expense = $500,000 x 0.09 = $45,000

Interest expense saved from bond conversion = $45,000 x (1 - 0.30) = $31,500

Net income available to common shareholders from bond conversion = $31,500

The new diluted earnings per share would be:

Diluted earnings per share = (Net income available to common shareholders + Preferred dividends + Potential bond interest savings) / Weighted average number of common shares outstanding

Diluted earnings per share = ($300,000 + $50,000 + $31,500) / 224,167 = $2.09

However, the conversion of the bonds is dilutive since it would increase the number of common shares outstanding. Since the assumed market price is higher than the conversion price, the bonds are expected to be converted. Therefore, the potential effect from the bond conversion is considered dilutive and excluded from the calculation.

Thus, the diluted earnings per share for 2017 is $1.68. Therefore, the best answer is B.

Information Concerning the Capital Structure of Shelmardine Corporation Follows