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Coral Co has net profit for the year ended 30 September 20X5 of $10,500,000. Coral hashad 6 million shares in issue for many years. On 1 October 20X4 Coral issued a convertiblebond. It had an initial liability element of $2,500,000, and the market interest rate for non‐convertible instruments is 8%. The bond is convertible in five years, with 50 shares issued forevery $100 nominal of convertible bond held. Coral Co pays tax at a rate of 28% What is theDiluted Earnings per Share figure?A 177.4¢B 175.0¢C 147.6¢D 146.8¢

Question

Coral Co has net profit for the year ended 30 September 20X5 of 10,500,000.Coralhashad6millionsharesinissueformanyyears.On1October20X4Coralissuedaconvertiblebond.Ithadaninitialliabilityelementof10,500,000. Coral hashad 6 million shares in issue for many years. On 1 October 20X4 Coral issued a convertiblebond. It had an initial liability element of 2,500,000, and the market interest rate for non‐convertible instruments is 8%. The bond is convertible in five years, with 50 shares issued forevery $100 nominal of convertible bond held. Coral Co pays tax at a rate of 28% What is theDiluted Earnings per Share figure?A 177.4¢B 175.0¢C 147.6¢D 146.8¢

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Solution

To calculate the Diluted Earnings per Share (DEPS), we need to adjust the earnings and the number of shares for the effects of the convertible bond.

Step 1: Calculate the interest expense that would have been saved if the bonds were converted into shares. This is done by multiplying the initial liability element of the bond by the market interest rate for non-convertible instruments.

Interest expense saved = 2,500,000∗82,500,000 * 8% = 200,000

Step 2: Adjust the net profit for the after-tax interest expense saved. This is done by adding the interest expense saved to the net profit and then subtracting the tax on the interest expense saved.

After-tax interest expense saved = 200,000∗(1−28200,000 * (1 - 28%) = 144,000

Adjusted net profit = 10,500,000+10,500,000 + 144,000 = $10,644,000

Step 3: Calculate the number of shares that would be issued if the bonds were converted. This is done by dividing the initial liability element of the bond by the nominal value of the bond and then multiplying by the number of shares issued for every nominal of convertible bond held.

Number of shares issued = 2,500,000/2,500,000 / 100 * 50 = 1,250,000 shares

Step 4: Adjust the number of shares for the effect of the convertible bond. This is done by adding the number of shares issued to the number of shares in issue.

Adjusted number of shares = 6,000,000 + 1,250,000 = 7,250,000 shares

Step 5: Calculate the DEPS. This is done by dividing the adjusted net profit by the adjusted number of shares.

DEPS = $10,644,000 / 7,250,000 = 146.8¢

So, the answer is D 146.8¢.

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