To calculate Basic Earnings Per Share (EPS) and Diluted EPS for LMN Inc., let's break it down step by step.
1. Calculate Basic EPS
Formula for Basic EPS:
\[ \text{Basic EPS} = \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Weighted Average Number of Common Shares Outstanding}} \]
Given data:
- Net Income = R150,000
- Preferred Dividends = R20,000
- Weighted Average Number of Common Shares Outstanding = 100,000
Calculation:
\[ \text{Basic EPS} = \frac{R150,000 - R20,000}{100,000} = \frac{R130,000}{100,000} = R1.30 \]
2. Calculate Diluted EPS
Formula for Diluted EPS:
\[ \text{Diluted EPS} = \frac{\text{Net Income} - \text{Preferred Dividends} + \text{Interest on Convertible Bonds}}{\text{Weighted Average Number of Common Shares Outstanding} + \text{New Common Shares from Conversions}} \]
Now, we need to account for the conversion of preferred shares and bonds:
a. Convert Preferred Shares:
- Convertible Preferred Shares: 10,000 shares, convertible into 5,000 common shares
- Net Income is unaffected by the conversion of preferred shares since we are already deducting the preferred dividends.
b. Include Convertible Bonds:
- Convertible Bonds = R50,000 with an interest rate of 5%
- Interest on Bonds = R50,000 * 5% = R2,500 (this interest would be added back to Net Income before calculating Diluted EPS)
Updated Calculation for Diluted EPS:
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Calculate adjusted Net Income: \[ \text{Adjusted Net Income} = R150,000 - R20,000 + R2,500 = R132,500 \]
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Calculate total shares after conversion:
- Weighted Average Common Shares Outstanding = 100,000
- New Common Shares from Convertible Preferred Shares = 5,000
- New Common Shares from Convertible Bonds = 2,000 \[ \text{Total Shares for Diluted EPS} = 100,000 + 5,000 + 2,000 = 107,000 \]
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Calculate Diluted EPS: \[ \text{Diluted EPS} = \frac{R132,500}{107,000} \approx R1.24 \]
Summary of EPS Calculations
- Basic EPS = R1.30
- Diluted EPS ≈ R1.24
Discussion on Effect of Conversion on EPS
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Impact on Basic EPS:
- The conversion of preferred shares does not affect the Net Income directly since they're already considered through the preferred dividends deduction. Consequently, Basic EPS remains R1.30.
-
Impact on Diluted EPS:
- The conversion of preferred shares into common shares dilutes earnings because the same income must be distributed over a larger number of shares. The Diluted EPS is reduced compared to Basic EPS (R1.24 vs. R1.30).
- Similarly, convertible bonds when converted into common shares also dilute EPS. The interest expense on the bonds is added back to Net Income, but the increase in the number of shares leads to a lower EPS due to the increased denominator.
In conclusion, both the conversion of preferred shares and convertible bonds generally leads to a decrease in EPS, indicating that shareholders may have a smaller slice of earnings per share, which is a typical consequence of share dilution.