A firm had 8,000 common shares outstanding at the end of the current period and earned $8,000 that period (net of tax).Also, options to purchase 5,000 shares at $5 each were outstanding all year.For the entire year the firm had $20,000 of 6% debt and $10,000 of 8% debt outstanding.The 8% debt is convertible into 500 common shares.The firm earns interest at 7 percent and has a 50 percent tax rate.The diluted earnings per share for the current year should be (rounded to the nearest cent):

Question

Quizplus · Accepted Answer

To calculate diluted EPS, first calculate basic EPS: $8,000 net income / 8,000 shares = $1.00. For dilution, consider the convertible debt and options. The convertible debt adds 500 shares, and the interest saved (after tax) is $400 (8% of $10,000 = $800, tax-adjusted = $400). Adjusted net income = $8,400. Options are in-the-money (exercise price $5 < market price implied by basic EPS $1.00), so use the treasury stock method: 5,000 options, proceeds $25,000, buy back 25,000/$1.00 = 25,000 shares, net increase = 0 shares. Diluted EPS = $8,400 / (8,000 + 500) = $0.69.

A Firm Had 8,000 Common Shares Outstanding at the End