Answer (B) is correct . The diluted earnings per share numerator consists of income available to common shareholders, that is, net income adjusted for the effect of convertible securities. The preferred dividends ($1,000,000 × 9% = $90,000) must be paid in any case because the preferred stock is not convertible. The after-tax effect of the bond interest ? ($2,000,000 × 7.5% = $150,000) is added back because the bonds are convertible. The numerator is thus calculated as follows: Net income $317,000 Less:? preferred dividends (90,000) Add:? savings on bond interest [$150,000 × (1.0 – 0.36)] 96,000 Income available to common shareholders $323,000 The denominator consists of the number of common shares outstanding, taking into account the effects of all dilutive securities. There are 100,000 shares of common stock outstanding ($1,000,000 ÷ $10 par). Adding the 50,000 shares that would be issued if the bonds were converted gives a denominator of 150,000 shares. Dwyer’s diluted earnings per share is thus $2.1533 ($323,000 ÷ 150,000).
Answer (A) is incorrect because Failing to adjust the numerator for the payment of preferred dividends and the after-tax savings on bond interest results in $2.11.
Answer (C) is incorrect because Failing to account for the conversion of the bonds in both the numerator and denominator results in $2.27.
Answer (D) is incorrect because Failing to add back the tax savings on bond interest to the numerator results in $2.51.
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