Earnings for a firm for the current year are $20,000 and the weighted average number of common shares before considering potentially dilutive securities is 18,000.The firm has no preferred shares but has 100,8%,$1,000 convertible bonds which were issued at face value many years ago.Each bond is convertible into 50 common shares.The tax rate is 40%.Compute EPS to be reported for this firm.(Rounded to the nearest cent)

Question

Quizplus · Accepted Answer

Basic EPS = Earnings / Weighted average number of common shares
Basic EPS = $20,000 / 18,000 = $1.11

To calculate diluted EPS, we need to find out whether the conversion of convertible bonds would have a dilutive effect on EPS. If the conversion results in an increase in the number of common shares outstanding, then diluted EPS will be lower than basic EPS.

Conversion of convertible bonds:
100 bonds * 50 shares per bond = 5000 new common shares
New shares outstanding = 18,000 + 5000 = 23,000

Diluted EPS = Earnings / Weighted average number of common shares (including potentially dilutive securities)
Diluted EPS = $20,000 / 23,000 = $1.08

Since diluted EPS ($1.08) is less than basic EPS ($1.11), the conversion of convertible bonds has a dilutive effect on EPS. Therefore, the answer is A.

Earnings for a Firm for the Current Year Are $20,000