Can someone help me understand why Pref Stock dividends aren't subtracted from the numerator? I thought PS dividends were always subtracted. I don't understand the explanation.
Question # 1066 | Blueprint Area: 1 D : Public Company Reporting Topics (U.S. SEC Reporting Requirements, Earnings Per Share and Segment Reporting)
The following information relates to the capital structure of Parke Corporation:
December 31
Previous Current
Outstanding shares of:
Common stock 90,000 90,000
Preferred stock, convertible into 30,000 shares of common 30,000 30,000
10% convertible bonds, convertible into 20,000 shares of common $1,000,000 $1,000,000
During the current year, Parke paid $45,000 dividends on the preferred stock, which was earned in this year. Parke's net income for the year was $980,000 and
the income tax rate was 40%.
For the current year ended December 31, diluted EPS is
A. $9.82
B. $8.29
C. $7.71
D. $7.43
The correct answer is (D).
Basic Earnings per share (EPS) is computed by dividing net income less preferred stock dividends by the weighted average shares of common stock outstanding.
Diluted EPS adjusts this calculation to reflect all potentially dilutive securities. To compute diluted EPS for this question, the convertible securities are assumed to have been converted at the beginning of the year.
The preferred stock dividend of $45,000 is added back to the numerator (canceling out its original subtraction, since in this question we already have Net Income, Preference Dividend wasn’t subtracted and hence need not be added back) and the 30,000 shares of converted common stock are added to the denominator.
The bond interest expense, net of tax, of $60,000 [($1,000,000 × 10%) × (1 – 40%)] is added back to the numerator as it was subtracted from Net Income and the 20,000 shares of converted common stock are added to the denominator.
Diluted EPS = $980,000 Net income + $60,000 Bond interest (net tax) = $7.43
90,000 (CS) + 30,000 (conv. PS) + 20,000 (conv. bonds)
