CFA Practice Question

There are 534 practice questions for this study session.

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)?

A. $0.87
B. $0.80
C. $0.88
Correct Answer: B

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.

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)
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