- CFA Exams
- CFA Level I Exam
- Study Session 7. Financial Reporting and Analysis (2)
- Reading 21. Understanding Income Statements
- Subject 7. Earnings per Share

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**CFA Practice Question**

Crimson Corporation had 3 million shares of common stock outstanding throughout the year in 2015. During the year, it issued five thousand, $1,000 convertible bonds with an interest rate of 8%. These bonds were issued at par on 1/1/2015. Each bond is convertible into 10 shares of common stock. Assuming Crimson had a net income of 2.4 million for 2015 and has an effective tax rate of 40%, what is its diluted EPS (rounded)?

B. $0.80

C. $0.88

A. $0.87

B. $0.80

C. $0.88

Correct Answer: B

3,000,000 shares + (5,000 x 10 shares) = 3,050,000

This is based on the following calculation:

$2,400,000+ [400,000 x (1-.40)] = $ 2,640,000

3,000,000 shares + (5,000 x 10 shares) = 3,050,000

where 400,000 represents the interest expense on the convertible debt which would be avoided if converted.

Diluted EPS = 2,640,000/3,050,000 = 0.87. Basic EPS = 2.4/3 = 0.80. So, the diluted EPS should actually be 0.80.

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**User Contributed Comments**
23

User |
Comment |
---|---|

eavotri |
The interest added should be after tax. |

Gina |
eavotri, this has nothing to do with "after tax". the conversion of the bonds is antidilutive (basic EPS < diluted EPS), hence you would report the basic EPS. |

eavotri |
I stand corrected. |

juncfa2 |
basic EPS is: 2.4/3 = 0.8 < 0.87, so it's anti-diluent. In that case, not included in the calculation. diluted EPS is 0.8. |

cbb1 |
I agree that the answer s/b the Basic EPS of $.80; Diluted EPS can never be greater than Basic EPS. |

danlan |
Simply calculate the Basic EPS = 0.8 and we can choose B. Since diluted EPS can not be greater than 0.8, other answers are all wrong. |

surob |
danlan is right. No calculation is needed for dilutive EPS. Once you have basic EPS, you have to check the answers. That is it. |

missmalik |
if conversion increase EPS, the security is anti diluted as far as I know.... So here we will take Basic earning per share as our ans.... if security is decreasing EPS then its diluted and our answer will be A not B. |

StanleyMo |
nice question. |

rethan |
Thanks Gina for that explanation! |

latteLover |
where does the $400,000 interest expense come from? |

MUTE |
5,000 bonds x $1,000 face value x 8% interest rate = $400,000 |

nayagan |
good question |

georgek |
great question. just remember to not shortcut the process with these questions. go through the steps of calc'ing basic, calc'ing dilution. it'll save you a few points here and there (and could mean pass rather than fail) |

bundy |
trick question |

DonAnd |
Good point Danlan! |

YOUCANDOIT |
not really a trick question, the convertible bond is anti-dilutive (increases EPS instead of decreasing it), therefore you do not include it into the dilutive EPS calculation...however, the question does not ask you to calculate the basic EPS which is sort of misleading i guess |

justbassbaby |
excellent question testing the concept! |

Saxonomy |
What did we learn today... IF THEY ASK YOU TO CALC DILUTED EPS, ALWAYS CALC BASIC EPS AS WELL. Darn CFA. |

ddrmax |
tricky. had to compare with basic EPS. If the basic EPS is higher, then the dilute effect (or antidilute) is ignored |

Slavyanka |
nice question! |

bsm9 |
Nice question. Tricky |

jonan203 |
nice one CFA, i see what you did there... dilutive < basic antidilutive = irrelevant (as far as this question is concerned) |