- 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**

The Fischer Company had a net income of $1,500,000. Fischer paid preferred dividends of $5 on each of their 100,000 preferred shares. There are 1 million Fischer common shares outstanding. In addition to the common and preferred stock, Fischer has $25 million in 4 percent bonds (par value: $100) outstanding. Each bond is convertible into 4 common shares. If Fischer's tax rate is 40 percent, what is its diluted earnings per share?

A. $1.00

B. $0.80

C. $0.33

**Explanation:**The numerator is net income plus pre-tax interest. The number of bonds is $25 million / $100 = 250,000. The bonds are convertible into 250,000 x 4 = 1 million common shares. Diluted EPS = [$1,000,000 + $1,000,000(1 - 0.4)]/[1,000,000 + 1,000,000] = $0.80

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**User Contributed Comments**
13

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

haarlemmer |
What a fool I am! Tha par-value of the bond here is unnecessary! |

danlan |
Preferred dividend was counted, so the numerator is 1500000-5*100000+1000000*(1-0.4)=1600000 |

linr0002 |
NI includes preferred dividends Basic EPS does not, add back pref div when working with Basic EPS |

harshjit |
For diluted EPS, after-tax interest on convertible bond is added back to net income in the numerator, assuming the bonds are converted into stocks. |

angelafan |
isn't this convertible debt is anti-diluted? |

ljamieson |
not antidilutive b/c lowers EPS from basic. dil'd EPS = [1,500,000-5*100,000-.04*25,000,000]/[1,000,000+4*250,000] = .8 |

tobikemper |
In the LOS it says the calculatio formula for Diluted EPS is given as follows: Diluted EPS = (Net Income - Preferred Dividends + Adjustments for Conversions) / (Weighted Average Number of Common Shares Outstanding + Equivalent Number of Potential Common Shares from the Conversion of All Outstanding Dilutive Securities) Therefore: [1,500,000 - (5 * 100,000) + (5 * 100,000) +(25,000,000 * 0.04 * (1 - 0.49))] / [1,000,000 + 100,000 + ((25,000,000 / 100) * 4)] = 2,100,000 / 2,100,000 = 1 => Diluted EPS = 1 Did I do something wrong? |

tobikemper |
Sorry, must be 0.40 for the tax rate, not 0.49! |

panvino |
Tobikemper - i made the same mistake. It doesnt say the preferred stock is convertible, hence denominator is simply 1m + 1m. |

potocah |
why is NI= 1mi? Since it is a diluted EPS, shouldnt we add the 500.000 back? |

gaetmichel |
NI: 1.5m - 0.5m = 1m. 0.5m is the dividends paid to preferred shareholders. |

davcer |
Basic. Eps is 1 |

farhan92 |
I was way too tired to compute the diluted so assumed it was anti dilutive. :/ |