Diluted EPS Calculation

Step 1: Calculate Basic EPS

Basic EPS = (Net Income - Preferred Dividends) / Weighted Average Common Shares Outstanding

Basic EPS = (£1,800,000 - £600,000) / 500,000 Basic EPS = £1,200,000 / 500,000 = £2.40

Step 2: Check if Convertible Preferred Shares are Dilutive

For convertible preferred shares, we use the if-converted method:

1. Adjust numerator: Add back preferred dividends that would not be paid if converted
2. Adjust denominator: Add common shares that would be issued upon conversion

If-converted EPS calculation:

• Adjusted numerator: £1,800,000 (no subtraction of preferred dividends since they wouldn't be paid if converted)
• Adjusted denominator: 500,000 + (25,000 × 4) = 500,000 + 100,000 = 600,000 shares

If-converted EPS = £1,800,000 / 600,000 = £3.00

Step 3: Determine Dilutive Effect

• Basic EPS = £2.40
• If-converted EPS = £3.00

Since £3.00 > £2.40, the convertible preferred shares are anti-dilutive (they would increase EPS, not decrease it).

Step 4: Apply Dilution Rules

According to accounting standards:

1. Only dilutive securities are included in diluted EPS calculation
2. Anti-dilutive securities are excluded
3. Diluted EPS should be less than or equal to basic EPS

Since the convertible preferred shares are anti-dilutive, they should not be included in the diluted EPS calculation.

Step 5: Final Diluted EPS

Diluted EPS = Basic EPS = £2.40

Verification:

• Basic EPS = £2.40
• If-converted EPS = £3.00 (anti-dilutive)
• Therefore, diluted EPS = £2.40

Answer: £2.40 (Option A)