Answer (A) is correct . DEPS is net income available to common shareholders plus amounts that would not have had to be paid if dilutive potential stock had been converted, divided by common shares outstanding plus the weighted-average number of additional shares of common stock that would have been outstanding if dilutive potential common stock had been converted. Thus, the denominator of the EPS calculation equals the 80,000 common shares on December 1, Year 1, plus the 20,000 shares that could be issued if the bonds were converted, for a total of 100,000 shares. The bonds are deemed converted at the beginning of the year. The numerator is the $107,000 of net income plus an adjustment for interest that would not have been paid if the bonds had been converted. The hypothetical interest saved is $16,000 ($200,000 of bonds × 8%). However, income would not be increased by $16,000 because the interest was tax deductible. Thus, the after-tax increase in net income would have been $10,560 [$16,000 × (1.0 – .34)]. Adding the $10,560 to the reported income of $107,000 produces a numerator of $117,560. Dividing the $117,560 by the 100,000 shares presumed outstanding results in a DEPS of $1.18 per share.
Answer (B) is incorrect because This figure is calculated using net income of $107,000.
Answer (C) is incorrect because This figure is calculated using 10% as the bond interest rate instead of 8%.
Answer (D) is incorrect because This figure is calculated using $107,000 net income plus the unadjusted $16,000 interest that would have been paid if bonds had not been converted.
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