FA Module 7 Diluted EPS for convertible preferred shares practice exam questions
(The attached PDF file has better formatting.)
In 20XX, a firm has net income of 2,170. Its capital structure consists of
● 510 common shares outstanding
● 15 convertible preferred shares outstanding, convertible into 8 common shares each
In 20XX, the firm pays dividends of 4.30 per common share and 9.00 per convertible preferred share.
Question 7.1: Net income available to common shareholders
What is the firm’s net income available to common shareholders?
Answer 7.1: 2,170 – 15 × 9 = 2,035
(net income available to common shareholders = net income minus dividends paid to preferred shareholders)
Question 7.2: Basic earnings per share
What is the firm’s basic earnings per share?
Answer 7.2: 2,035 / 510 = 3.990
(net income available to common shareholders / weighted average common shares outstanding)
Question 7.3: Dividend payout ratio
What is the firm’s dividend payout ratio?
Answer 7.3: 4.30 / 3.990 = 107.77%
(Dividends per share / earnings per share; firm paid more as shareholder dividends than it earned)
Question 7.4: Earnings retention rate
What is the firm’s earnings retention rate?
Answer 7.4: 1 – 107.77% = -7.77%
(earnings retention rate = complement of dividend payout ratio)
Question 7.5: If-converted method numerator
What would net income be if the convertible preferred shares had been converted at the beginning of the year?
Answer 7.5: 2,035 + 15 × 9.00 = 2,170
(net income available to common shareholders + preferred shares outstanding × preferred share dividend)
Question 7.6: If-converted method denominator
What would the weighted average common shares outstanding be if the convertible preferred shares had been converted at the beginning of the year?
Answer 7.6: 510 + 15 × 8 = 630
(weighted average common shares outstanding + preferred shares outstanding × conversion rate)
Question 7.7: Diluted earnings per share
What is the firm’s diluted earnings per share?
Answer 7.7: 2,170 / 630 = 3.444
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