Checking each part of Diluted EPS

Reviewing FSA because I bombed that section on my first mock exam. Let’s say you have a diluted EPS question with both convertible debt and convertible preferred stock. If you were asked for diluted EPS, would you check if the conversion of each SEPARATE part is not anti-dilutive? Is that being paranoid? ie. check if convertible debt is anti-dilutive separately and then check if convertible preferred stock is anti-dilutive. Cuz… hypothetically one could be dilutive and the other anti-dilutive. Curious of your thoughts guys & gals.

I think later is the best option. First check Warrants/Stock options if those are dilutive and then Bonds or visa versa. Then do the math.

yes… test them separately

warrants/options have to be dilutive (assuming that the strike price is less than the average price over the last year) given that there is nothing in the numerator…

correct willispierre but there is an exception to it. If a company is experiencing a net loss then relationship about warrants/options reverses.

check both separately, but it will clear in question if you are adding a comparable amount to earning or weightd avg shares already there in basic eps better to check for anti dilution.

true, but you probably would not have in-the-money options/warrants if a company is experiencing net losses. It may happen in a rare occasion, but I would doubt that you would see that on the exam.

I read a question in schweser on cumulative preferred stock and non cumulative preferred stock. Found no material on that in the CFAI books itself. Is that there in the syllabi?

I don’t remember seeing it in books/schweser before. But here is the definition from A type of preferred stock with a provision that stipulates that if any dividends have been omitted in the past, they must be paid out to preferred shareholders first, before common shareholders can receive dividends. A preferred stock will typically have a fixed dividend yield based on the par value of the stock. This dividend is paid out at set intervals, usually quarterly, to preferred holders. If a company runs into some financial problems and is unable to meet all of its obligations, it will likely suspend its dividend payments and focus on paying the business-specific expenses. If the company gets through the trouble and starts paying out dividends again, it will first have to pay back all of the dividends that are owed to preferred share holders.

I dont’ see at all what test for conv pref div and conv debt your taking about, I just had a look at CFAI book and they only talk about if-converted method (no test appear here) Can some explain how we can verify if one is antidilutive ??? Thanks

To test, calculate Basic EPS first. Then take each dilutive piece and test by dividing how it would change income available to shareholders by the new shares it would create. For example, say you have calculated Basic EPS to be 2.00/share and you have potentially dilutive preferred stock with total preferred dividends of 10,000 and a conversion feature that will increase shares outstanding by 4,000. 10,000 / 4,000 = 2.50 Since 2.50 is greater than basic EPS, these are non-dilutive. However, if your total preferred dividends had been 6,000 then 6,000 / 4,000 = 1.5 and these would be dilutive. Hope that makes some sense. -Stillwagon

Warrants/Options if [(Avg Mkt Price - Exercise Price) / Avg Mkt Price] +ve then anti dilutive and this calculation returns how many shares will be added in denominator. For Convertible Bonds use per share effect: [Interest ( 1 - tax rate) / # of shares that bonds can be converted to] > Basis EPS then convertible bonds are anti dilutive.

This is how i see the difference between cumulative and non cumulative preferred stock: If the preferreds are not cumulative, dividends unpaid may not be subtracted from the numerator. But if they are cumulative, then since these dividends will have to be paid one day i think you should still subtract them, even if they weren’t paid for the year… Being convertible or not is a completely separated question i suppose. In any case i hope this kind of question won’t show up in this year’s exam.