The profit before interest and taxation for the year ended 31 December 2016 amounted to £1,050,000 and arose exclusively from continuing operations. The rate of tax is 30%. The issued share capital of Entity A at 31 December 2015 was 2,000,000 ordinary shares of £l each. On 1 January 2016, Entity A issued £1,500,000 of 7% convertible loan stock for cash at par. Each £100 nominal of the loan stock may be converted into 140 ordinary shares at any time after 1 January 2019. 05 Requirement Test whether the potential shares are dilutive.

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EXPERT ANSWER

Step 1

Profit before interest and taxes1,050,000
Less:Interest expenses (1500000*7%)105,000
Profit before taxes945,000
Less:Taxes expenses (945000*30%)283,500
Net profit661,500
Net income available for ordinary shareholders661,500
Divided by:weighted average share in ordinary shares2,000,000
Basic earnings per share0.33

Step 2

Convertible loan
Interest expenses (1500000*7%)105,000
Less:tax on interest (105000*30%)31,500
Adjustment in income for convertible loan73,500
Conversion ratio140
Multiply by:Number of loan stock (1500000/100)15,000
Number of share adjusted2,100,000
Adjustment in income for convertible loan73,500
Divided by:Number of share adjusted2,100,000
Earning per incremental share0.04

Answer

Earning per incremental share of 0.04 is less than basic earnings per share of 0.33.It means the potentials share is dilutive.
Yes, potentials share is dilutive.