New Gestalt, Inc., a software firm had a net income of 1.7 million last year. It has 200,000 common shares and 300,000 convertible bonds with face value of 100 outstanding. The convertible bonds carry a coupon of 4% and can be converted one-for-one. The average stock price last year was 39 and the maximum price was 57. The effective interest rate on the convertible debt is 8%. New Gestalt issued 100,000 preferred shares with face value 100 and a coupon of 5% on March 31st of last year. Assume the convertible bonds are dilutive and that New Gestalt faces a 30% tax rate. Given the above, New Gestalt's Diluted EPS equals ________.
Answer(s): C
Diluted EPS = (Net Income - Preferred dividends + interest on convertibles net of taxes)/(weighted # of common shares assuming convertible conversion) In this case, numerator = 1.7 million - 375,000 + 300,000*8%*100*(1-30%) = 3,005,000. The denominator equals 200,000 + 300,000 = 500,000. Therefore, Diluted EPS = 6.01. Note that the interest expense on the convertible bond is calculated using the effective interest rate, not the coupon rate.
Which of the following are changes in accounting principle?
Answer(s): D
Both I and III involve changes in the method of accounting.
Under accrual accounting, which of the following is/are correct?
Answer(s): A
Accrual accounting requires that revenues and gains be recognized when earned and expenses and losses be recognized when incurred. Hence, revenue recognition is completely separate from cash flows. In the sales process, the earnings process is completed when goods are delivered and that's when revenue is recognized under accrual accounting.
Stockholders' equity may contain all of the following components, except:
Answer(s): B
Classified as a liability, minority interests in consolidated subsidiaries represent the equity held by investors other than the subject firm in those subsidiaries.
The "Treasury Stock" method of calculating EPS involves:
In the Treasury stock method, it is assumed that the proceeds from the exercise of warrants and employee call options are used to repurchase shares at the average market price during the period. Considering call option exercise when the average stock price is below strike price is incorrect since it is an irrational strategy and leads to anti-dilution of EPS.
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