On December 31, 2017, Merlin Company had outstanding 400,000 shares of common stock and 40,000 shares of 8% cumulative preferred stock (par $10). On February 28, 2018, Merlin issued an additional 36,000 shares of common stock. A 10% stock dividend was declared and distributed on July 1, 2018. On September 1, 2018, 9,000 shares were retired. At year-end, there were fully vested incentive stock options outstanding for 30,000 shares of common stock (adjusted for the stock dividend). The exercise price was $18. The market price of the common stock averaged $20 during the year. Also outstanding were $1,000,000 face amount of 10% convertible bonds issued in 2015 and convertible into 50,000 common shares (adjusted for the stock dividend). Net income was $900,000. The tax rate for the year was 40%.

Question: Compute basic and diluted EPS (rounded to 2 decimal places) for the year ended December 31, 2018.

diluted earnings per share = (net income - preferred dividends) / (weighted average + diluted shares) = ($900,000 - $32,000) / (424,000 + 3,000) = $2.03

Explanation:

Dec. 2017 outstanding common stocks 400,000

outstanding preferred stocks 40,000 x 8% x $10 = $32,000

February 28, 36,000 common stocks were issued

September 1, 9,000 shares were retired

diluted shares 30,000, exercise price $18, market price $20

net income $900,000

weighted common stocks:

400,000 x 12/12 = 400,000

36,000 x 10/12 = 30,000

- 9,000 x 8/12 = -6000

total = 424,000

diluted stocks:

[($20 - $18) / $20] x 30,000 = 3,000 diluted shares