Diluted EPS

Warrants, options, and rights are dilutive if the exercise price is

• A. higher than the stocks’ average market price

• B. higher than the stocks’ end-of-year market price

• C. lower than the stocks’ end-of-year market price

• D. lower than the stock’s average market price

Answer explanation

Options are dilutive when they are in-the-money. Options are said to be in-the-money if the exercise price is lower than the market value of common shares.

Which of the following is the least dilutive when considering incremental EPS?

• A. Stock options

• B. Convertible preferred shares

• C. Contingently issuable shares

Answer explanation

Both stock options and contingently issuable shares never have an effect on the EPS numerator, meaning they are always dilutive.

Katie Company issued stock options on February 1, 20X2. For the purpose of calculating dilutive EPS, the options should be assumed to have been exercised on

• A. December 31, 20X2

• B. February 1, 20X2

• C. January 1, 20X2

Answer explanation

If options were issued during the year, backdate only to the date of issue. Then calculate a subtotal at this point. If adjust the denominator as through these shares were issued at the beginning of the period, using the treasury stock method.

100,000 preferred shares with a $1 preference dividend concerted into 100,000 common shares on October 1, 20X4. To backdate the conversion in the calculation of diluted EPS you would:

• A. add $100,000 to earnings available to common

• B. add 75,000 shares to WACSO

• C. add 100,000 shares to WACSO

• D. add 25,000 to earnings available to common

Answer explanation

Earning available to common is calculated by using net income minus preferred share dividends

Comprehensive earnings are $938,000. The weighted number of shares outstanding is 100,000. 100,000 convertible preferred shares with a $1 cumulative preference dividend have been outstanding all year. Each preference share can be converted into on common share. Options outstanding for the full year would have resulted in a net adjustment for assumed exercise of 5,000 shares. Basic EPS would be         

Answer explanation

Net profit available to ordinary shareholders=$938,000-100,000*$1=838,000

WACSO=100,000

Basic EPS=838,000/100,000=$8.38

XX Inc. earns a net profit of $200,000, and it has 5,000,000 common shares outstanding that sell on the open market for an average of $12 per share. In addition, there are 300,000 options outstanding that can be converted to XX’s common stock at $10 each. Calculate the amount of diluted earnings per share.

Answer explanation

EPS 200,000/5,000,000=0.04

              300,000*$10=$3,000,000

              $3,000,000/12=250,000

 300,000-250,000=50,000 $200,000/ (5,000,000+50,000) =$0.0396           

For the purpose of deriving EPS, securities are considered dilutive if they are capable of

• A. increasing the company’s debt to equity ratio

• B. reducing the amount of dividends per share

• C. reducing the number of outstanding shares

• D. reducing earnings per share