CFA Practice Question

There are 534 practice questions for this study session.

CFA Practice Question

The Gaffe Company had a net income of $1,500,000. Gaffe paid preferred dividends of $5 on each of its 100,000 preferred shares. Each preferred share is convertible into 20 common shares. There are 1 million Gaffe common shares outstanding. In addition to the common and preferred stock, Gaffe has $25 million of 4 percent bonds outstanding. If Gaffe's tax rate is 40 percent, what is its diluted earnings per share?
A. $0.33
B. $1.00
C. $0.50
Explanation: Earnings available to common shares is net income available to common shares ($1 million) plus the preferred dividends ($500,000). The preferred shares are convertible into 100,000 x 20 = 2 million common shares.

User Contributed Comments 16

User Comment
Gina ie would it be only if they were preferred bonds?
Gina why is the interest expense adjusted for tax not added to NI, ie + $600,000?
tony1973 The bonds are not convertible so it does not affect EPS at all. kinds of tricky here.
EBIII all in all 3 mio common shares. Why they calculate with 2 mio common shares only? please HELP :-)
sharapov net income is $1,500,000, not $1M!
shame sharapov: but 1M is available to common shareholders and 0.5 million to preferred ones. The total is still 1.5 million.
bachi $1.5 M + $ .5 M (Div ) / ( 1 Mil Shares + 2 Mil conv Shares ) gives me .6 . We have to add back the $.5 M dividend right. Any one ?
MadsI I think I get it. You never add back the dividend for preferred stocks if you work from net income. That would be creating money out of nowhere, you only add back interest because it has been subtracted to get to net income. You have to add back the dividend when working from basic EPS because it has already been subtracted.

So now you have 1.5/3=0.5. Makes sense?
danlan Madsi, good comments.
americade I had to read MadsI a couple of times before I got it, the question says preferred "DIVIDENDS" not "INTEREST." Dividends are not added back for the reason MadsI wrote.
Shelton basic-EPS=($1.5m-$0.5m+$0.5m)/(1m+2m)=0.5
Janey A comment from an earlier question stated:
If Convertible Pref Stock (NI-Pref Div)+Pref Div
If Non-Convertible Pref Stock (NI-Pref Div)
angelafan I agree with Shelton. because preferred shares are converted to common share, that's why 0.5m dividends need to be added back.
azramirza the trick is thoughbond outstanding is given..they havent been need to ignore the same...
JonClark Is this correct?
First convert everything to common shares:
You get 2m converted preferred + 1m existing common = 3m common shares.
You can now ignore preferred dividends, so
Net income/common shares = 1.5M/3M = .5
endurance ignore the preferred dividends in the numerator -the issue is convertible to common shares!

The preferred shares is however dilutive, so add the convertible shares in the denominator.

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