Diluted EPS

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Danhoop21

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When caculating diluted EPS, why don't you add preferred dividends back to net income if the preferred stock is covertible? Wouldn't the company no longer pay the preferred dividend if the preferred stock is converted to common stock?

I ask beceasue with convertible debt you add back the interest so why wouldn't you want to do the same thing with preferred stock?

Thank you. I appreciate the help on this topic.
 
Interest is an expense, which is normally deducted to arrive at net income. Thus to negate the effect for convertible debt you need to add it back.

Dividends are paid out of cash and are not reflected in the income statement, so no addback is needed.



Edited 1 time(s). Last edit at Wednesday, October 11, 2006 at 10:19PM by Super I.
 
Actually, I believe you do add it back to NI, IF and ONLY IF, the conversion would have been likely in the year, b/c if it was converted there would be no Preferred Dividends. For example if the conversion price is $5/share and the average market price during the year was $20/share you would assume that the convertible preferred stock could be exercised and therefore there would be no pref. Div.

I'll have to recheck the book, but I beleive that is what it states more or less.
 
when calculating EPS (both basic and dilluted) in the top part of equation should be "earnings to common equity holders". That's why we get rid of preferred dividends here.

In case of convertible bonds, we assume that there is no bond anymore (it is converted into stocks already -->>number of stocks added to denominator), that's why we add back interest payments to net income
 
Yes, but if the preferred stock was converted, there are not Pref Dividends, hence you do not subtract it from NI.
 
Schweser makes no note to my knowledge of anything OTHER than the standard EPS formula which begins with NI-Pref divs. While they do note in a subsequent paragraph about computing for the option dilution (MP-EP)/MP * contracts, I dont believe they mention NOT removing pref divs.
 
I don't know how Schweser explains dilluted EPS, but CFA curriculum extends basic EPS formula tp dilluted EPS one. So it means that "NI-preferred dividends" is established fact, when adding/substracting other components to the numerator in EPS dilluted formula.
 
My last post is a touch misleading. Obviously Schweser explains the Diluted EPS equation (hence my notation of the option dilution calculation), I just meant that there is no entry, to my recollection, regarding the add back of divs from converted Prefered shares.
 
One of the most important things you need to do for the exam is to learn to READ THE QUESTION CAREFULLY.

The phrase "add back preferred dividends" is not the same as "don't subtract out preferred dividends"

The first is "+PD" and the second is "(blank)"

My answer was correct given the question asked.
 
Super I, you are correct in that fact that if you never took Pref Div's out then you don't need to add it back in. The books show you to do NI - Pref Div + Pref Div if converted, but an easier and faster way is to just take NI if the pref shares were converted. I think everyone is kinda looking at it in two different ways. You only have to add it back if you took it out to begin with or for some reason the Questions said NI includes pref dividends and as a result you would have to add it back. You say Potatoe I say Potato...
 
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