Question

Poppy Corporation owns 60 percent of Seed Company's common shares. Balance sheet data for the companies on December 31, 20X2, are as follows: Poppy Corporation Seed Company Assets Cash Accounts Receivable Inventory Buildings and Equipment Less: Accumulated Depreciation Investment in Seed Company Stock Total Assets Liabilities and Owners' Equity Accounts Payable Bonds Payable Common Stock ($10 par value) Retained Earnings Total Liabilities and Owners' Equity $ 51, eee 86,000 119, eee 680,000 (210,000) 141,000 $ 907,000 $ 33,000 52,000 97,000 390,000 (78,000) $494,000 $ 117,000 250, eee 300,000 240,000 $ 907,000 $ 59,000 200,000 100,000 135,000 $494,000
The bonds of Poppy Corporation and Seed Company pay annual interest of 8 percent and 10 percent, respectively. Poppy's bonds are not convertible Seed's bonds can be converted into 10,000 shares of its company stock any time after January 1, 20X1. An income tax rate of 40 percent is applicable to both companies. Seed reports net income of $36,000 for 20x2 and pays dividends of $10,000 Poppy reports income from its separate operations of $46,000 and pays dividends of $20,000
Required: Compute basic and diluted EPS for the consolidated entity for 20x2. (Round your answers to 2 decimal places.) Basic earnings per share Diluted earnings per share

Answer 1

Answer:

Poppy Corporation

Consolidated EPS

Basic Earnings per share = $67,600/10,000 = $6.76 per share.

Diluted earnings per share = $74,800/10,000 = $7.48 per share

Explanation:

With the conversion of the Seed's bonds, the interest of $20,000 would be included in its income.  And an after tax increase of $12,000 (after taking out tax of 40% on $20,000) would be added to the net income, making the net income to become $48,000 ($36,000 + 12,000).  The group's share of the net income would become $28,800 ($48,000 x 60%).  This amount is added to the Poppy's net income of $46,000 to get a consolidated net income of $74,800 after the conversion of the bonds.

Before the conversion, the consolidated net income is $67,600 ($46,000 + 60% of $36,000).

EPS becomes diluted with the conversion of convertible debt securities.  The effect for a consolidated entity like Poppy is the increase in the net income attributable to the holding company with the elimination of the interest expense.  However, the number of shares outstanding for the group would remain the same as before the conversion since it was the bonds of the subsidiary that was converted and not the group's.