Can anyone explain this section as it pertains to the increase in the number of shares outstanding? Just not getting it.
The component of the diluted earnings per share denominator that includes the net of new shares potentially created by unexercised in-the-money warrants and options. This method assumes that the proceeds that a company receives from an in-the-money option exercise are used to repurchase common shares in the market. In order to comply with generally accepted accounting principles (GAAP), the treasury stock method must be used by a company when computing its diluted earnings per share (EPS). Investopedia Says… The net of new shares that are potentially created is calculated by taking the number of shares that the in-the-money options purchase, then subtracting the number of common shares that the company can purchase from the market with the option proceeds. This adds to the total number of shares in the denominator and lowers the EPS number. For example, assume that a company currently has in-the-money options that cover 10,000 shares with an exercise price of $50. If the current market price is $100, the options are in-the-money and, based on the treasury method, need to be added to the diluted EPS denominator. The proceeds the company will receive will be $500,000 ($50 x 10,000), which allows them to repurchase 5,000 shares on the market ($500,000/$100). Therefore, the net of new shares is 5,000 (10,000 option shares - 5,000 repurchased shares). Reference: Investopedia
(Avg Share Price - Orig share price)/Average share price
ditchdigger2CFA, don’t you sleep?
Not too often these days! I’m too worried about this exam! But, the treasury stock method assumes that warrants/options are outstanding and the company must honor the warrant/strike price. But, since the price is higher, they will need to buy at the average year’s price to honor the strike/warrant price.
think i have it now. 1. company can exercise options to create new shares. 2. however, it buys back shares from the market at the avg market price. 3. this reduces the total number of shares issued (Net shares) so the “new” shares issued is less than the total number granted by the exercise of the options.
Kinda. It is dilutive, so the share’s outstanding increase. Anti Dilutive is not looked at.
One important point is holding the treasury stock doesn’t give a Corporation voting rights on behalf of the number of Treasury stocks held.
It does not reduce the number of shares outstanding, shares just change hands: from the entity holding the shares in the market (and from whom the company buys back), to the owner of the warrants who decided to exercise the warrants. Since warrants get exercise whenever the exercise price is lower than the average annual price, then the amount received from the exercise of the warrant is lower than required to buy the shares needed in the exchange, hence the company has to issue some supplementary shares. At no point in time is there talk about treasury stock (which would be stock bought back from the market and held by the company).
Why does the company use the proceeds from exercise of options to repurchase shares?
They don’t.
This is hypothetical.