### CFA Practice Question

There are 534 practice questions for this study session.

### CFA Practice Question

The following data pertains to the Sapphire Company:

• Net income equals \$15,000.
• 5,000 shares of common stock issued on January 1st.
• 10 percent stock dividend issued on June 1st.
• 1000 shares of common stock were repurchased on July 1st.
• 1000 shares of 10 percent, par \$100 preferred stock, each convertible into 8 shares of common stock, were outstanding the whole year.

What is the company's diluted earnings per share (EPS)?
A. \$1.15
B. \$1.20
C. \$1.00
Explanation: Number of average common shares:

1/1 5,500 shares issued (includes 10% stock dividend on 6/1) x 12 = 66,000
7/1 1,000 shares repurchased x 6 months = -6,000 = 60,000
60,000 shares/12 months = 5,000 average shares
Preferred dividends = (\$10)(\$1000) = \$10,000
Number of shares from the conversion of the preferred shares = (1000 preferred shares)(8 shares of common/share of preferred) = 8000 common shares
Diluted EPS = [\$15,000(NI) - \$10,000(pfd) + \$10,000(pfd)]/5000(common shares) + 8000 (shares from the conv pfd shares)
= \$15,000/13,000 shares = \$1.15/share

This number needs to be compared to basic EPS to see if the preferred shares are antidilutive.

Basic EPS = [\$15,000(NI) - \$10,000(preferred dividends)]/5,000 shares = \$5,000/5,000 shares = \$1/share

Since the EPS after the conversion of the preferred shares is greater than before the conversion, the preferred shares are antidilutive and they should not be treated as common in computing diluted EPS. Therefore, diluted EPS is the same as basic EPS or \$1/share.

User Comment
murli Stock dividend = full impact, share repurchased = pro-rata impact!
swift why don't the converted shares get 10%dividend - shouldn't it be 8800 shares not 8000?
ragingrazz Shouldn't this be \$1.92/sh after conversion?
yesficom Yes, 1.92. I think the numerator should be adjusted for only 10,000 preferred dividends not any more paid, not as if they were also paid.
wollogo 1.92 is wrong, Net Income doesn't include preferred dividends. If the prefered shares were converted then no prefered dividends would be paid which is why it nets to zero, -10K + 10K.
gweiden This question isn't as hard as it looks if you look at the answer choices you are given. The first step in solving this problem should be to calculate basic EPS which is \$1.00. By definition, diluted EPS must be lower. There are no choices here that are lower than \$1.00 so it is safe to assume that the preferred stock is antidilutive. Pick the \$1.00, it's the lowest possible anser.
Shelton 1. Pref.Div. = 1000*\$100*10% = \$10k (critical!)
2. Basic EPS = (NI-Pref.Div)/CS = (\$15k-\$10k)/5k=1.0 => (D)
dimanyc gweiden, great point!
achu Remember , dividends get weighted back to INITIAL date held from which they were generated!
HYcds why are the shares outstanding multiplied by 12?
mishis This is considering the 8,000 was converted beg of year but no stock dividend applied to it. Is this big assumption always assumed? Otherwise, diluted EPS would be 1.09.
Andrewua great!anti-dilutive shares are not included in calculation of dilutive eps!
serboc why isn't the repurchase not included?
clarelau It's included. Basic EPS: (15K-10K)/(5K*1.1*1y-1K*0.5year)=5K/5K=1. It's the weighted average.
boddunah assumption should be to calculate basic eps to make sure convertible pref. stock is dilutive. nice.atleast should have mentioned about basic eps. well we need to remember to calculate basic eps for every freeking dilutive question.
cleopatraliao this is so tricky!!i would just choose A straight away if im under exam condition...
cleopatraliao didnt quite get the explanation. why is it 60,000 for share repurchase??isnt it 6000??? and why when calculated diluted EPS, the answer is like 15,000-10,000+10,000? shouldnt it just be 15,000-10,000 for the numerator?
schweitzdm The explanation here is different from others where they weigh it by t/12. This one they are using the method for taking the # of months outstanding and then at the end, dividing by 12.

Can someone please explain how to tell which method to use?
asalonga7 What happened to the stock dividend in the denominator of the basic EPS calculation - why is it only 5000?
asalonga7 never mind i missed the share repurchase
birdperson you can quickly realize this is anti-dillutive as (pref div/# of shares if pref converted) > basic EPS ((15000 - 10000)/common)
praj24 Great question. definitely clears a lot of things up! well played AN
CJPerugini Is preferred really converted to 8,000? If stock dividends and stock splits behave the same, this would mean that a 2 for 1 stock split would deface the value of your preferred by 50%.
bwils39 Does the 10% stock dividend issued on 6/1 play into this at all?
Albert123 Why is the stock dividend of 10% calculated for 12 months not 7? Ita 0.1 x 5000= 500 but we should multiply that by 7 ( it was issued in the first of june) it would yield 3500)
dferreira Shouldn' this be:
WANSO: 5,000x1.1x(6/12)+(5,000-1,000)*1.1*(6/12)
That equals 4,950 and not 5,000