P16-7 (Computation of Basic and Diluted EPS) The information below pertains to

Prancer Company for 2007. Net income for the year $1,200,000 8% convertible bonds
issued at par ($1,000 per bond). Each bond is convertible into 40 shares of common
stock. 2,000,000 6% convertible, cumulative preferred stock, $100 par value. Each share
is convertible into 3 shares of common stock. 3,000,000 Common stock, $10 par value
6,000,000 Common stock options (granted in a prior year) to purchase 50,000 shares of
common stock at $20 per share 500,000 Tax rate for 2004 40% Average market price of
common stock $25 per share There were no changes during 2007 in the number of
common shares, preferred shares, or convertible bonds outstanding. There is no treasury
stock. Instructions (a) Compute basic earnings per share for 2007. (b) Compute diluted
earnings per share for 2007.

(a) Basic EPS = $1,200,000 – ($3,000,000 X .06)

600,000*

= $1.70 per share

*$6,000,000 ÷ $10

(Net income – Preferred dividends) + Interest

savings (net of tax)
(b) Diluted EPS =
Average common shares + Potentially dilutive
common shares

= $1,200,000 – $180,000a + $96,000b

600,000 + 10,000c + 80,000d

= $1,116,000
690,000

= $1.62 per share

a
$3,000,000 X .06; Preferred stock is not assumed converted since conversion
would be antidilutive.
b
$2,000,000 X .08 X (1 – .40)

c
Market price – Option price X Number of options = incremental shares
Market price
 $25 – $20 X 50,000 = 10,000
$25
d
($2,000,000 ÷ $1,000) X 40 shares/bond