We have the following data for a company:

• Net income= $12,000
• Preferred dividend= $2,000
• Weighted Average Shares Outstanding= 10,000
• Preferred Stock Outstanding = 1,000
• 50 convertible bonds, $1,000 par, 6%. Each bond is convertible into 100 shares

Basic EPS = (12,000 – 2,000)/10,000 = 1

If the convertible bonds are converted into shares, the total new shares issued will be:

\= 50*100 = 5,000

If the convertible bonds are converted into shares, there will be no interest expense. Therefore the net income will increase by = 50*1000*0.06(1-0.40) = 1,800

Diluted EPS = (12,000 – 2,000+1,800)/(10,000+5,000) = 0.78

We should check whether the diluted EPS is less than basic EPS. Only if it is less, the convertible bonds will be considered to be dilutive and will be included in the calculation of dilutive EPS.