Number of common stock to add in Diluted EPS

[rexthedog]

OK, With the below question I said the shares outstanding was 1,000,000

My reasons were this: At the bottom of the question it says the convertible bonds are dilutive therefore they surely should not be included in the calculation (brings earnings down)

Warrant Excercise price is out of the money so these are not included either.

Therefore is the answer not just the same 1,000,000

In the answer tab below they have converted the bonds and i’m, not sure why? Am I missing something?

Thanks so much

An 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 bonds (conversion ratio 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 the convertible bonds are 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) 1,100,000. C) 1,266,667.

Your answer: A was incorrect. The correct answer was B) 1,100,000.

When the capital structure contains options or warrants, the treasury stock method uses the average price. In this situation, the warrants are antidilutive because the exercise price of the warrant ($25) is higher than the market price of the stock ($20). Thus, warrants are excluded. Otherwise, common shares would be reduced.

original shares of common stock

Then add the impact of the bond conversion:

(10,000)(20) × (6/12) = 100,000

Thus, the adjusted denominator for fully diluted EPS is:

1,000,000 + 100,000 = 1,100,000

[rexthedog]

Oh, I’ve noticed the question has asked for the Diluted EPS?

Does this mean we should still go ahead and convert anything that causes dilution?

[tickersu]

@rexthedog

OK, With the below question I said the shares outstanding was 1,000,000

My reasons were this: At the bottom of the question it says the convertible bonds are dilutive therefore they surely should not be included in the calculation (brings earnings down)

Warrant Excercise price is out of the money so these are not included either.

Therefore is the answer not just the same 1,000,000

In the answer tab below they have converted the bonds and i’m, not sure why? Am I missing something?

Thanks so much

An 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 bonds (conversion ratio 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 the convertible bonds are 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) 1,100,000. C) 1,266,667.

Your answer: A was incorrect. The correct answer was B) 1,100,000.

When the capital structure contains options or warrants, the treasury stock method uses the average price. In this situation, the warrants are antidilutive because the exercise price of the warrant ($25) is higher than the market price of the stock ($20). Thus, warrants are excluded. Otherwise, common shares would be reduced.

original shares of common stock

Then add the impact of the bond conversion:

(10,000)(20) × (6/12) = 100,000

Thus, the adjusted denominator for fully diluted EPS is:

1,000,000 + 100,000 = 1,100,000

Yes, anything dilutive that is reasonably expected to be exercised/converted. One thing to recall about this calculation is that it will be a weighted average for the outstanding shares. The bonds would come out to 200,000 shares, but this is only for the remaining 6 months in the year. Given that the warrants are out of the money, you add [(6/12)*200,000] to the original 100,000 shares outstanding (since they were present since the beginning of the year).