Analyst gathered the following data about a company -1,000,000 shares of common are outstanding at the beginning of the year -10,000 6% convertible le bonds (conversion ration is 20 to 1) were issued at par June 30 of this year -The company has 100,000 warrants outstanding all year with an exercise price of $25 per share -The average stock price for the period is $20 and the ending stock price is $30 If convertible bonds are c considered dilutive, the number of shares of common stock that the analyst should use to calculate diluted earnings per share is a 1,000,000 b 1,016,667 c 1,100,000 d 1,266,667 Answer is C, please kindly explain why??
It seems like we have: +116,667 common shares (7/12th of the year for all convertible bonds exercised - It’s June, not July…) +100,000 common shares (if all warrants exercised) - 125,000 common shares (the funds from the warrants are used to buy back common*) Yielding +91,667… So maybe it’s one of those “closest to…” questions? Or have I made a mistake? *I have hand-written into my book that the notional warrant buy-back happens at the “Average price”, so total notional buyback would be (25*100,000)/20.
Hah, ignore that 7/ths thing. It’s June 30th, not June 1st. So my real answer would be +75,000.
Or maybe the real answer is just that we don’t include the effects of the warrants because the average price is below the exercise price.
- The exercise price < the average stock price => the warrant was not exercised. - The if converted method assumes the convertible stock would be converted at the beginning of the year so the number of outstanding common share should be 1,000,000 + (10,000*20) = 1,200,000 I think it could be a mistake. Correct me of i am wrong. Cheers
Agree with manovar and nby… Convertible bonds June30th = 6/12; So 100,000*2=200,000 for 6months = 100,000 shares Warrants Avg 20= Out of the money – don’t excercise So 1.1m shares…
use the wieghted time average (1) 1,000,000* 12/12= 1,000,000 (2) 10,000*6/12*20= 100,000 (because the shares were hold only for 6 months out of 12 and the is the conversion ratio is 20 to 1) Now you do (1)+(2)= 1,100,000
So the book really doesn’t discuss what price should be used to determine whether or not warrants would be exercised… The example on page 172 (V3) uses the average price, but the book doesn’t seem to have a question like this (with an average price below the exercise price, but a ending price above it). Intuitively, as an investor, I would want the effect of warrants included in diluted EPS if I thought exercise was likely. If the ending price is 5 dollars above the exercise price, I’d say exercise was likely. Does anyone know of the hard rule on this?
1,000,000 shares outstanding all year x 12mos = 12,000,000 10,000 Convertible Bonds (20:1) issued June 30 * 6mos = 1,200,000 Warrants are out of the money (don’t exercise) = 0 --------------- 13,200,000/12 = 1,100,000