During 2021, Farewell Inc. had 500,000 shares of common stock and 50,000 shares of 6% cumulative preferred stock outstanding. The preferred stock has a par value of $100 per share. Farewell did not declare or pay any dividends during 2021. Farewell's net income for the year ended December 31, 2021, was $2.5 million. The income tax rate is 25%. Farewell granted 10,000 stock options to its executives on January 1 of this year. Each option gives its holder the right to buy 20 shares of common stock at an exercise price of $29 per share. The options vest after one year. The market price of the common stock averaged $30 per share during 2021. What is Farewell's diluted earnings per share for 2021, rounded to the nearest cent?

$4.40 per share

Explanation:

The formula and the computation of the diluted earning per share is shown below:

Diluted earning per share =(Net Income - preferred Dividend) ÷ (weighted number of shares outstanding)

where,

Net income is $2.5 million

Preference dividend is

= 50,000 shares × $100 × 6%

= $300,000

And, the weighted number of outstanding shares is

= Number of shares of common stock + incentive stock options

= 500,000 shares + 10,000 shares ÷ $30 per share

= 500,000 shares + 333.33 shares

= 500,333.33 shares

So, the diluted earning per share is

= ($2,500,000 - $300,000) ÷ (500,333.33 shares)

= $4.40 per share

It shows the relationship between the net income after considered the preference dividend and the weighted number of outstanding shares

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