CFA Practice Question

There are 534 practice questions for this study session.

CFA Practice Question

On 12/31/2014, Morgan Corporation's capital structure is as follows:

  • Common stock outstanding: 200,000
  • Non-convertible, $100 par, 6% preferred stock: 37,700 shares
  • 8.00 %, $1,000 convertible bonds: $1,500,000
  • Stock options to purchase 33,000 shares of common stock at $30.00 a share
  • Average market price of common stock during 2015 was $39.

The following events occurred in 2015:

  • On 9/1/2015, Morgan sold 283,000 additional shares of common stock.
  • Net income for the year was $1,375,000 after taxes.
  • The 8.00% convertible bonds are convertible into 80 shares of common stock for each $1,000 bond.
  • The tax rate for 2015 is 25%

What is the diluted EPS for 2015?
A. 2.94
B. 1.78
C. 3.22
Explanation: Shares of stock at beginning of year: 200,000
Shares issued on 9/1/2015: (1/3 * 283,000) 94,333
Total shares for basic EPS: 294,333
Bonds: 1,500,000/1000 = 1,500 * 80
Conversion of bond into new common shares: 120,000
Options: 33,000 * 30.00 = $990,000/$39 = 25,385
33,000 - 25,385 = 7,615.38
Total for diluted EPS: 421,949

Preferred stock dividend = 0.06 * $100 = 6 * 37,700 = $226,200
Bond interest = 1,500,000*8.00% = $120,000*0.75 = $90,000

($1,375,000 - $226,200 + $90,000) /421,949 = 2.94

User Contributed Comments 20

User Comment
bernar If you see this question in the test skip, you are going to loose precious time. Very time consuming question.
ballstocfa beats me how he got 2.94 .can someone explain to me those numbers at the end
swift 1375k-226.2k(non convert bond)+90(saving from not paying coupon) = 1238800
wa#shares = 200k+120k+7615(from option ex)+1/3*283k = 421948
haarlemmer The answer is somehow wrong.

Note the time the new share are issued (9/1/2010). The length of the old share in existence is only 8 months, not 9! The correct time should be 10/1/2010 or 0/30/2010. to discount the old shares 8/12 should be used!

I truly hope we won't face this sort of questions in the exam, I spent more than 5 mintues in caculating this. What makes the problem worse is that not only should you calculate the dilutive eps, you should bear in mind to do the basic as well. in case the basic earning is less, basic earing should be used!
jost haarlemmer: they did use 4 months (12 - 8), not 3 months. I guess the answer is correct.
SnowWhite The answer is correct.
BADGUY yeah the answer is correct and you do not have to calculate the basic eps first;find out if each category of shares are dilutive or not thats all.
gene80 shoot... took me 10 min to do this.. yup.. absolutely not worth the time.. ouch..
motoloco not prob in the exam .... but usefull to check if we mastered the topic
achu Options 33,000 * 30.00 = $990,000/$39 = 25,385
33,000 - 25,385 = 7,615.38

Subtract (#options * strike price) / (curr mkt price) from # raw options to get "wtd options for diluted EPS."
steved333 Yeeeaahhh!!! That one was tough, and it took about 2 or 2-1/2 minutes to do, but I got it!!! If it's on the test, come back to it if there's time. You'll need it!
JimM Basic EPS:
(NI - preferred div) / weighted basic shares

Diluted EPS:
(NI - preferred div + after tax bond interest) / (weighted basic shares + conv bond shares + option shares)

Weighted basic shares:
Beginning share count
Add (subtract) fractional year issued (purchased)

Diluted basic shares:
Weighted basic shares
Add all conv bond shares
Add option shares as: # options minus (# x strike / avg price)
Don't include preferred shares!
Criticull there will be some questions that take 1 minute or less, there will be some that take 2 or more. This is the latter.
Bparsons Don't include preferred shares EVEN if they are NONCONVERTIBLE.
lsum Hi, I am not so sure why the bond interest is added to the numerator.

The convertible were converted into 80 shares during 2010. Therefore no interest should have been paid out. Therefore it should not be added back. Am I wrong ?
boddunah its time consuming question . but its
medium on difficulty scale. u can do it if you remember to deduct pref. divided. which i did not.
rjdelong Isum - I see what you mean. Tricky question. In a sense it's confusing because now that its been paid back you would think you don't need to add it back anymore. Looks like in fact, you do. You add it back because it's money you would have paid out in interest on your bond debt, but since there is no bond debt anymore bc of conversion to equity there is no bond interest paid in 2010. This raises pre-tax income for the year (so you do pay tax on this savings) so you only get 75% of it.
Clembn Chances of forgetting something are high, time to do this question is at least 3min.
More time efficient to take a random 1/3 chance
Lambo83 Just imagine if the preferred shares were convertible. That would make this question even more difficult
Inaganti6 the answer is right the question is - is it worth attempting ? ridiculously time consuming.
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