Dilutive EPS

CFA Level I
#1

Slighlty confussed here… Assume that the exercise price of an option is $10, and the average market price of the stock is $13. Assuming 999 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the Diluted EPS? A. 999 B. 768 C. 206 D. 231 correct (999)(10) = 9,990 9,990/13 = 768 999 - 768 = 231 Why is it not just 768? why would one subtract from 999? Thanks!!

#2

Following the option exercise, 768 shares would be bought back form the market with $13/share, for the $9,990 collected. But the exercise is 1 option for 1 share, so 999-768=231 would need to be issued to honor the exercise, since the 768 existed already.

#3

Lets say all 999 options get exercised. That will give the company 999x10 = $9990. Now the company will use this money to buy back stocks from the market. Given the market price for the stock is $13, the company will be able to buy back 9990/13 = 768 stocks. So basically 999 new stocks came into the market but, simultaneously 768 of those were taken back by the company, therefore only 999-768 = 231 new stocks are now part of the outstanding stocks in the market. Hope this helps.

#4

Thanks map1, axl…been a real big help!!! I think i will dedicate my CFA to the great folks on this site. : )

#5

I always calculate the # of shares as ((Stock Price - Strike Price)/Stock Price) * # of options. If you do it this way you get (13-10)/13 * 999 = 230.5 or approx 231. You get the same answer as the other explanation.

#6

Whoa, that really is a good way of doing it. Cheers

#7

Please ignore this post…its just for personal ref. When considering the impact of warrants on earnings per share, the method to calculate the number of shares added to the denominator is derived using which method? A. Completed contract method. B. Weighted average method. C. Treasury Stock method. D. Cost recovery method. The treasury stock method assumes the hypothetical funds received by the company from the exercise of the options are used to purchase shares of the company’s common stock in the market at the average market price.