# warrants outstanding - basic & diluted

A company has 1,000,000 warrants outstanding at the beginning of the year, each convertible into one share of stock with an exercise price of \$50. No new warrants were issued during the year. The avg. stock price during the period was \$60 and the year end-end was \$45. What are the adjustment to be made? Basic … Diluted a) 0…166,667 b)0…0 c)166,667…166,667 d)166,667…200,000 This should be an easy one for you guys… My question is… Even if the option price is below the exercise price we take the options into account? So basically the idea is avg.price > exercise price and the options dilute the EPS?

Is something missing in there?? what about Net Income? we probably need that for EPS calculations, right? All I could figure out is the increase in the number of stocks if the warrents are exercised… (60 - 50)/ 60 * 1m = 166,666.667 [Treasury Stock Method] - Dinesh S

no they are asking just about the numbers to adjust the diluted… dinesh, you are right on the diluted and the basic remain obviously 0, but my question was, even if the exercise price is higher than market close of stock we take the options into consideration ?

Yes, we need to adjust for the addition in the number of shares only when the Avg Market Price is greater than the Exercies price… Warrent holders are give the option to convert their warrents into share of stock at a exercise price of \$45. It means that he could buy 1 share of stock (by exercising the option) at just \$45, when the market price of the stock was \$60 (~avg), then, why the heck will he buy it in open market @60 when he has the right to buy it at @45? So it’s only then EP < AMP, it matters the most… Lemme know if you get the point? - Dinesh S

Dinesh, now I’m getting confused when I thought I understood the problem. Since the warrants are exercised at \$50, but the market price at year end is \$45, then as you said nobody would exercise the option when the market is cheaper. So in that sense, why bother even considering the dilution in the first place?

Sorry, it was my typo… it’s pretty late already stratus, we never consider the year-end price (so forget that \$45 was ever given in this question…). now It’s just between AMP of \$60 and exercise price of \$50. Please re-read this now… I can’t edit my previous post… *************************************************** Yes, we need to adjust for the addition in the number of shares only when the Avg Market Price is greater than the Exercies price… Warrent holders are give the option to convert their warrents into share of stock at a exercise price of \$50. It means that he could buy 1 share of stock (by exercising the option) at just \$50, when the market price of the stock was \$60 (~avg), then, why the heck will he buy it in open market @60 when he has the right to buy it at @50? So it’s only then EP < AMP, it matters the most… Lemme know if you get the point? - Dinesh S ***************************************************

Thanks. I still wonder, though, at least at year end why would any warrant holder exercise the warrant when it’s cheaper to buy the security at market price? Or is the idea that for dilutive securities you never care where market price is, and have to consider any possibility that a warrant holder would exercise it, regardless of whether that move makes financial sense or not?

Stratus, the Average price of \$60 means the stock price “might have” come down below \$50 (which is the EP of the option), which renders the option as in-the-money option and given the chance for the warrant holders to convert their warrants to share of stock… But yes, no person would exercise their options at \$50 when the stock price was \$45 (at year end), unless until gun-pointed to do so. Warrants are potentially dilutive securities. No of shares are adjusted only of AMP > EP - Dinesh S

the last price in the market is misleading I think You can’t really tell what would happen if you would buy 1 mil shares from the market, as in this example. the Average cost could be a lot higher, depending on liquidity, demand and supply etc

Some of you are missing the point. It is not whether warrant holders did or did not exercise their option, but it is simply a way to make financial analysis more helpful. What the balance sheet is telling you is that *if* warrant holders had decided to excercise this year, whenever it made financial sense for them (say back in June when the stock price was \$70, or any other day when the stock price was higher than %50), then EPS would be the diluted EPS you would see on the balance sheet. The closing price is completely irrelevant, but the average price is. Dreary

Yo Dreary - let’s not go exercising those options early…

Another point is what if half of those warrants were actually exerised during the year, how would you calculate your diluted EPS? A little tricky. Dreary

Dreary: Wouldn’t you basically multiply the result of TSM by the ((# of months remaining)/12) ?

If half of those warrants were actually exerised during the year, then you would simply take the remaining half as the relevant warrants outstanding when you calculate diluted EPS. Dreary

The average shares outstanding would change if the warrants were exercised during the year. The exercise of the warrants doesn’t affect the diluted EPS if the proceeds from the warrant exercise are used to buyback stock at the average price.