FA Module 8 Diluted EPS for convertible debt practice exam questions
covering convertible bonds, net income available to common shareholders, basic earnings per share, dividend payout ratio, earnings retention rate, If-converted method numerator, If-converted method denominator, diluted earnings per share
(The attached PDF file has better formatting.)
In 20XX, the corporate tax rate is 10% and a firm has net income of 3,170. Its capital structure consists of
● 610 common shares outstanding
● 6,120 (face value) of 6.40% convertible bonds, convertible into a total of 240 common shares
In 20XX, the firm pays dividends of 4.15 per common share.
Question 8.1: Net income available to common shareholders
What is the firm’s net income available to common shareholders?
Answer 8.1: 3,170
(Firm has not issued preferred shares, so no deduction)
Question 8.2: Basic earnings per share
What is the firm’s basic earnings per share?
Answer 8.2: 3,170 / 610 = 5.197
(net income available to common shareholders / weighted average common shares outstanding)
Question 8.3: Dividend payout ratio
What is the firm’s dividend payout ratio?
Answer 8.3: 4.15 / 5.197 = 79.85%
(Dividends per share / earnings per share)
Question 8.4: Earnings retention rate
What is the firm’s earnings retention rate?
Answer 8.4: 1 – 79.85% = 20.15%
(earnings retention rate = complement of dividend payout ratio)
Question 8.5: If-converted method numerator
What would net income be if the convertible debt had been converted at the beginning of the year?
Answer 8.5: 3,170 + 6,120 × 6.40% × (1 – 10%) = 3,522.51
(net income available to common shareholders + par value of convertible debt × coupon rate on convertible debt × (1 – tax rate) )
Question 8.6: If-converted method denominator
What would the weighted average common shares outstanding be if the convertible debt had been converted at the beginning of the year?
Answer 8.6: 610 + 240 = 850
(weighted average common shares outstanding + shares from convertible debt)
Question 8.7: Diluted earnings per share
What is the firm’s diluted earnings per share?
Answer 8.7: 3,522.51 / 850 = 4.144
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