Dilutive EPS

[SriHanuman]

Why do we add the tax rate(1-t) to the numerator while calculating the dilutive eps??
Dilutive Eps = int. inc - pref inc + convert. inc(1-t) / wt.avg.shares + convertible debt shares.
Pg69 Schweser 2015.

 

[S2000magician]

If convertible debt were converted, you wouldn’t have to pay interest on the debt, so you add back the interest.
But if you don’t pay interest, then your expenses are lower, so your taxable income is higher, so you have to pay more in taxes.
The net effect is that your net income will increase by the amount of interest times (1 − t), where t is the marginal (not average) tax rate.
I wrote an article on EPS that may be of some help here: http://financialexamhelp123.com/earnings-per-share-eps/

 

[SriHanuman]

Thnx for the reply S2000magician . I still need some clarification

I may be wrong in my understanding …..Interest on debt …. we are assuming that the bonds are bougth wiht loan amount.

Thnx in advance…

 

[S2000magician]

SriHanuman wrote:I may be wrong in my understanding …..Interest on debt …. we are assuming that the bonds are bougth wiht loan amount.

I’m not sure I understand what you’re asking here.
We’re assuming that the bonds are converted to stock. When that happens, we no longer have to pay interest on the bonds. So we remove that interest expense (net of taxes) from our income statement, increasing our net income.

 

[Flashback]

SriHanuman wrote:
Thnx for the reply S2000magician . I still need some clarification

I may be wrong in my understanding …..Interest on debt …. we are assuming that the bonds are bougth wiht loan amount.

Thnx in advance…

Bonds are not bought, bonds are issued. Interest costs deduct corporate income tax base, thus should be added back in any calculation.

 

[SriHanuman]

Thnx got it…