Analyzing Income Statements: practice question

Correct answer: B

Working: Basic = 1,800,000/400,000 = 4.50; if-converted: numerator = 1,800,000 + 1,000,000 × 6% × (1 − 0.30) = 1,842,000; denominator = 440,000; diluted = 1,842,000/440,000 ≈ 4.19.

Explanation: Under the if-converted method the bonds are assumed converted from the start of the year: after-tax interest of 1,000,000 × 6% × (1 − 0.30) = 42,000 is added back to the numerator and 40,000 shares to the denominator, so diluted EPS is 1,842,000/440,000 ≈ 4.19, which is below the basic 4.50 and therefore dilutive. The $4.09 figure enlarges the denominator to 440,000 shares but leaves the numerator at 1,800,000, forgetting that conversion also removes the interest expense. The $4.50 figure is simply basic EPS and ignores the potential dilution embedded in the conversion terms altogether.