Question

Bravo, Inc. , owns all of the stock of Echo, Inc. For 2021, Bravo reports income (exclusive of any investment income) of $480,000. Bravo has 80,000 shares of common stock outstanding. It also has 5,000 shares of preferred stock outstanding that pay a dividend of $15,000 per year. Echo reports net income of $290,000 for the period with 80,000 shares of common stock outstanding. Echo also has a liability from its 10,000, $100 bonds that pay annual interest of $8 per bond. Each of these bonds can be converted into two shares of common stock. Bravo owns none of these bonds. Assume a tax rate of 21 percent. What amount should Bravo report as diluted earnings per share

Answer 1

Bravo, Inc. should report a diluted earnings per share (EPS) of $8.182 by considering the net income exclusive of preferred dividends, adjusting Echo's net income for tax effects on bond interest, and accounting for all potential convertible securities.

Step-by-step explanation:

To calculate Bravo, Inc.'s diluted earnings per share (EPS), we must account for the impact of all potential convertible securities, which in this case includes Echo, Inc.'s convertible bonds. Firstly, we calculate Bravo's net income by subtracting the preferred dividend from the reported income.

Net income available for common shareholders = $480,000 - $15,000 = $465,000

Next, we add Echo, Inc.'s net income as it is a wholly owned subsidiary:

Total Net Income = $465,000 (Bravo) + $290,000 (Echo) = $755,000

Now, we account for the tax effect on Echo's bond interest which would no longer be deductible if the bonds are converted, thus:

Adjusted Echo Net Income = $290,000 (Echo) + ($8 * 10,000 bonds) * (1 - 0.21 tax rate) = $290,000 + $63,200 = $353,200

Adding Echo's adjusted net income to Bravo's income:

Total adjusted net income = $465,000 + $353,200 = $818,200

Finally, we determine the number of shares, considering the dilutive effect of Echo's convertible bonds:

Bravo's shares = 80,000

Echo's convertible shares = 10,000 bonds * 2 shares per bond = 20,000 shares

Total diluted shares = 80,000 + 20,000 = 100,000 shares

Diluted EPS is then calculated by dividing the adjusted net income by the total diluted shares:

Diluted EPS = $818,200 / 100,000 = $8.182