Question 4.17: A Diluted EPS Calculation Using the If-Converted Method for ...
A Diluted EPS Calculation Using the If-Converted Method for Convertible Debt
Oppnox Company reported net income of $750,000 for the year ended 31 December 2005. The company had an average of 690,000 shares of common stock outstanding. In addition, the company has only one potentially dilutive security: $50,000 of 6 percent convertible bonds, convertible into a total of 10,000 shares. Assuming a tax rate of 30 percent, calculate Oppnox’s basic and diluted EPS.
If the convertible debt had been converted, the debt securities would no longer be outstanding; instead, an additional 10,000 shares of common stock would be outstanding. Also, if such a conversion had taken place, the company would not have paid interest on the convertible debt of $3,000, equivalent to $3,000(1 – 0.30) = $2,100 on an after-tax basis. To calculate diluted EPS using the if-converted method for convertible debt, the amount of net income available to common shareholders is increased by $2,100. Also, the weighted average number of shares in the denominator increases by 10,000 shares.
EXHIBIT 4-10 Calculation of Diluted EPS for Oppnox Company
| Using the If-Converted Method: Case of Preferred Stock | ||
| Basic EPS | Diluted EPS Using If-Converted Method | |
| Net income | $750,000 | $750,000 |
| After-tax cost of interest | 2,100 | |
| Numerator | $750,000 | $752,100 |
| Weighted average number of shares outstanding | 690,000 | 690,000 |
| If converted | 0 | 10,000 |
| Denominator | 690,000 | 700,000 |
| EPS | $1.09 | $1.07 |