1 January Shares in issue 1,000,000Profit for the year ended 31 December $200,00031 March Company issues $200,000 6% convertible bonds Terms of conversion:100 shares/$100 if within five years110 shares/$100 if after five yearsAn equivalent loan without the conversion rights would have required an interest rate of 8%.The company’s tax rate is 33%Basic EPS: $200,000/1,000,000 = $0.20Required:Calculate diluted EPS
Question
1 January Shares in issue 1,000,000Profit for the year ended 31 December 200,000 6% convertible bonds Terms of conversion:100 shares/100 if after five yearsAn equivalent loan without the conversion rights would have required an interest rate of 8%.The company’s tax rate is 33%Basic EPS: 0.20Required:Calculate diluted EPS
Solution
To calculate the diluted EPS, we need to consider the effect of the convertible bonds.
Step 1: Calculate the interest expense saved due to the lower interest rate on the convertible bonds.
The company would have paid 8% interest on a similar loan without conversion rights, but it is only paying 6% on the convertible bonds.
Interest saved = (200,000 * 6%) = $4,000
Step 2: Adjust the interest saved for tax.
Interest is tax-deductible, so the company saves tax on the interest saved.
After-tax interest saved = 2,680
Step 3: Add the after-tax interest saved to the profit.
Adjusted profit = 2,680 = $202,680
Step 4: Calculate the number of new shares that would be issued if the bonds were converted.
The terms of conversion state that 100 shares would be issued for every $100 of bonds, so
Number of new shares = 100 * 100 = 2,000,000 shares
Step 5: Calculate the diluted EPS.
Diluted EPS = Adjusted profit / (Existing shares + New shares) = 0.06756
So, the diluted EPS is approximately $0.068.
Similar Questions
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