Ottey Corporation issued 4 million of 10 year 7 callable

convertible #1347

Ottey Corporation issued $4 million of 10-year, 7% callable convertible subordinated debentures

on January 2, 2014. The debentures have a face value of $1,000, with interest payable
annually. The current conversion ratio is 14:1, and in two years it will increase to 18:1. At the
date of issue, the bonds were sold at 98 to yield a 7.2886% effective interest rate. Bond
discount is amortized using the effective interest method. Ottey's effective tax was 25%. Net
income in 2014 was $7.5 million, and the company had 2 million shares outstanding during the
entire year. For simplicity, ignore the requirement to record the debentures' debt and equity
components separately.

Instructions

(a) Prepare a schedule to calculate both basic and diluted earnings per share for the year
ended December 31, 2014.

(b) Discuss how the schedule would differ if the security were convertible preferred shares.

(c) Assume that Ottey Corporation experienced a substantial loss instead of income for the
fiscal year ending December 31, 2014. How would you respond to the argument made by a
friend who states: "The interest expense from the conversion of the debentures is not actually
saved, and there is no income tax to be paid on the additional income that is assumed to have
been created from the conversion of the debentures."

Ottey Corporation issued 4 million of 10 year 7 callable convertible

ANSWER
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