# Logic behind diluted EPS for warrants?

If a company has 100k warrants outstanding, which are convertible into 1 common shares each at \$50 per share, and assuming that the average common share price is \$60, you would calculate diluted EPS by adjusting outstanding shares by adding: (\$60 - \$50)/\$60 * (100k warrants) = 16,667 shares But why only 16,667 shares? If all the warrants are exercised, then you would have an additional 100,000 shares outstanding, right? But that’s not what the formula says. The way I would do it, is to increase outstanding shares by 100k, and add \$50,000 to net income (proceeds from the warrants exercise). Isn’t this correct? Dreary.

Dreary when considering diluted earnings with warrants it is assumed the treasury stock method is in place, that is, the proceeds received from the warrants are used to buy stocks from the market and reduce the ‘dillution’

Because everyone wants to hide dilution so they “assume” that all the proceeds from warrant exercise will go to repurchase stock. Yeah right. The net income thing is a joke, right?

But this method is the entire concept of the treasury method… which works as 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). 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).

wow cpk123 that is a comprehensive answer

The question is about the number of shares outstanding, not the effect of the dilution. To go back to the original example, the company had 100,000 warrants exerciseable into 100,000 shares of stock. Yet, the formula for calculating diluted EPS shows only 16,667 additional shares outstanding. If I owned those warrants, and I decide to exercise them, there should be 100,000 *new* shares issued for me, and that’s an increase of 100k shares in outstanding shares. Adding the proceeds of the exercise (\$50,000) to the denominator (which is what I meant when I suggested adding it to NI - same effect if it weren’t for Joyey’s sarcasm) you would get the correct answer, and the correct number of outstanding shares in the denominator, unless I am really tired. Dreary

the number of stock issued by exercising the warrant are 100000 but it is assumed that with the proceeds the company would buy from the market all the shares they can (that’s why they give the average market price). so you are right about shares issued but incorrect about those considered outstanding

Yes, I am tired. Ok, so in the example I cited what will end up happening is that the company will take the \$5M proceeds from the warrants exercise, and buys 83,333 shares from the market (\$5M/\$60 per share). At this point, the number of shares outstanding hasn’t changed… only shares changing hands. The remaining shares (100,000 - 83,333 = 16,667 shares) are issued by the company, and the number of outstanding shares increases accordingly. Great. Of course, the method I suggested works just as well (only if it were allowed): The company would issue all the required shares, in this case all 100,000 shares, and the proceeds (the \$5M) will be added to the numerator. Diluted EPS would be the same. Thanks to all Dreary

Try that calculation with some made-up data…

Lets try it: Assume NI = \$2 M, and WASO = 1 M shares, outstanding warrants = 100 k, at \$50. Diluted EPS = (NI + proceeds from warrant exercise) / (WASO + exercised warrant shares) = (\$2 M + \$5 M) / (1 M shares + 100 K shares) = \$6.36 basic EPS = \$2 M / 1 M shares = \$2 Whoa! This is anti-dilutive! So, I guess that’s why it is not allowed? But it is interesting, though. Think about it: The company could collect the \$5 M from the warrant holders, and issue fresh 100k shares from treasury. If EPS increase (as I suppose in this example) then shareholders shouldn’t mind! There must be something wrong here. Dreary

I dont think that would be included in net income you issue new equity and receive money for it so the common equity should go up 5 mil and cash should go up 5 mil