Question 4.20: An Antidilutive Security For the year ended 31 December 2006...
An Antidilutive Security
For the year ended 31 December 2006, Dim-Cool Utility Company had net income of $1,750,000. The company had an average of 500,000 shares of common stock outstanding, 20,000 shares of convertible preferred, and no other potentially dilutive securities. Each share of preferred pays a dividend of $10 per share, and each is convertible into three shares of the company’s common stock. What was the company’s basic and diluted EPS?
If the 20,000 shares of convertible preferred had each converted into 3 shares of the company’s common stock, the company would have had an additional 60,000 shares of common stock (3 shares of common for each of the 20,000 shares of preferred). If the conversion had taken place, the company would not have paid preferred dividends of $200,000 ($10 per share for each of the 20,000 shares of preferred). The effect of using the if-converted method would be EPS of $3.13, as shown in Exhibit 4-12. Because this is greater than the company’s basic EPS of $3.10, the securities are said to be antidilutive and the effect of their conversion would not be included in diluted EPS. Diluted EPS would be the same as basic EPS (i.e., $3.10).
EXHIBIT 4-12 Calculation for an Antidilutive Security
| Basic EPS | Diluted EPS Using If-Converted Method | ||
| Net income | $1,750,000 | $1,750,000 | |
| Preferred dividend | –200,000 | 0 | |
| Numerator | $1,550,000 | $1,750,000 | |
| Weighted average number of shares outstanding | 500,000 | 500,000 | |
| If converted | 0 | 60,000 | |
| Denominator | 500,000 | 560,000 | |
| EPS | $3.10 | $3.13 | ←Exceeds basic EPS; security is antidilutive and, therefore, not included. |