Calculate the incremental EPS for the following instrument: Convertible bonds outstanding, effective yield of 7% and coupon rate of 7%
$2,000,000
Issue date
January 1, 2021
Maturity date
December 31, 2024
Conversion rate for each $1,000 bond
20 ordinary shares
Income tax rate
25%
A)$0.75
B)$0.88
C)$2.25
D)$2.63

Question

Quizplus · Accepted Answer

The incremental EPS calculation involves determining the additional earnings available to common shareholders per share if convertible securities were converted into common stock. Here's the breakdown:1. **Interest Expense Saved (Net of Tax):** Since the convertible bonds have a coupon rate of 7%, the annual interest expense is 7% of $2,000,000 = $140,000. The tax savings on this interest expense is 25% of $140,000 = $35,000. Therefore, the net interest expense saved is $140,000 - $35,000 = $105,000.2. **Additional Shares from Conversion:** The conversion rate is 20 shares per $1,000 bond, and there are $2,000,000 worth of bonds, which means there are 2000 bonds. Therefore, the conversion would result in 2000 * 20 = 40,000 additional shares.3. **Incremental EPS:** The incremental EPS is the net interest expense saved divided by the additional shares from conversion. So, $105,000 / 40,000 = $2.625.Therefore, the correct answer is D) $2.63, rounding to the nearest cent.

Calculate the Incremental EPS for the Following Instrument: Convertible Bonds