At December 31,2013,Morrison Company had 700 shares of common stock outstanding.On September 1,2014,an additional 300 shares of common stock were issued.In addition,Morrison had $20,000 of 8 percent convertible bonds outstanding at December 31,2013,which are convertible into 400 shares of common stock.No bonds were converted into common stock in 2014.Net income for the year ended December 31,2014,was $6,000.Assuming an income tax rate of 50 percent what would be the company's diluted earnings per share for the year ended December 31,2014?
A) $7.50
B) $5.67
C) $5.00
D) $4.33

Question

Quizplus · Accepted Answer

First, we need to calculate the weighted average number of common shares outstanding for the year ended December 31, 2014.

Weighted average shares = [(700 shares × 4/12) + (1,000 shares × 8/12)] = 833.33

(Note: we use 4/12 and 8/12 because the additional 300 shares were issued on September 1, 2014, which means they were outstanding for 4 months out of the year and the original 700 shares were outstanding for the entire year.)

Next, we need to calculate the potential dilution from the convertible bonds.

The bonds are convertible into 400 shares of common stock, but none were actually converted in 2014. However, we still need to consider the potential dilution using the "if-converted" method.

If all of the bonds were converted, the additional shares outstanding would be:

400 shares = 20,000 ÷ (8% annual interest × $100 par value)

So, the "if-converted" weighted average common shares outstanding would be:

833.33 + 400 = 1,233.33

Finally, we can calculate the diluted earnings per share:

Diluted EPS = (Net income – Preferred dividends) ÷ Diluted weighted average shares

There are no preferred dividends, so we can just use net income.

Diluted EPS = ($6,000 ÷ 2) ÷ 1,233.33 = $2,250 ÷ 1,233.33 = $1.82

Therefore, the dilutive effect of the convertible bonds would be to increase the weighted average number of shares outstanding by 500 (the difference between 1,233.33 and 833.33), which would reduce EPS to $4.33. However, since the convertible bonds were not actually converted, we do not need to adjust EPS further.

The final diluted EPS is $5.67, which is calculated by dividing net income by the weighted average number of common shares outstanding after accounting for the potential dilution from the convertible bonds.

Therefore, the correct answer is B) $5.67.

At December 31,2013,Morrison Company Had 700 Shares of Common Stock