Mcloone Co.'s basic EPS is $1.20. Mcloone has $10 million par value 5% Preference Shares outstanding that can be converted into 400,000 common shares. Is Mcloone required to report diluted earnings per share?
A. Yes, because the pref. shares are dilutive to EPS
B. No, because the pref. shares are not dilutive to EPS.
C. Yes, because the pref. shares are potentially dilutive to EPS.
Ans. C - Diluted EPS must be reported if a firm has any potentially dilutive securities outstanding. In this case, the security is anti dilutive (500000/400000 = 1.25$), which is greater than the basic EPS and the firm will report that diluted EPS is equal to basic EPS.
Can someone please simplify the explanation in the answer here. My answer was B given that they anti dilutive. What is the meaning of potentially dilutive ?
Potentially dilutive means that the securities have a chance of being dilutive towards the EPS. Firms that have potentially dilutive securities in their capital structure are required to report a dilutive EPS.
In Mcloone Co.'s case, they would have to report a diluted EPS along with their basic EPS, but would not include these preferred shares in the calculation of their diluted EPS because they are anti dilutive (EPS of the p shares is $1.25 which is greater than the basic EPS of $1.20)
Hope this helps, if someone has a better answer, feel free to correct me.
Thank you. But how would we ascertain if a security is potentially dilutive ?
So, Mcloone would report dilutive EPS as being equal to Basic EPS. Am I right ?
A security is potentially dilutive if it is convertible to common shares. It is dilutive if when converted Diluted EPSBasic EPS.
A company has a potentially dilutive capital structure if it includes stock options/warrants, convertible debt (bonds), or convertible preferred shares. When a company’s capital structure is potentially dilutive, they must report a diluted EPS along with the basic EPS.
In this case, I believe that the company would report both EPS as the same.