EPS & Dilutive Securities (17.4) Flashcards
Describe a simple capital structure
A simple capital structure is one that contains no potentially dilutive securities. A simple capital structure contains only common stock, nonconvertible debt, and nonconvertible preferred stock.
Describe a complex capital structure
A complex capital structure contains potentially dilutive securities such as options, warrants, or convertible securities.
Basic EPS equation
basic EPS = (net income−preferred dividends) / weighted average number of common shares outstanding
*Note: The current year’s preferred dividends are subtracted from net income because EPS refers to the per-share earnings available to common shareholders. Net income minus preferred dividends is the income available to common stockholders. Common stock dividends are not subtracted from net income because they are a part of the net income available to common shareholders.
Things to know about the weighted average shares outstanding calculation:
The weighting system is days outstanding divided by the number of days in a year, but on the exam, the monthly approximation method will probably be used.
Shares issued enter into the computation from the date of issuance. Reacquired shares are excluded from the computation from the date of reacquisition. Shares sold or issued in a purchase of assets are included from the date of issuance. A stock split or stock dividend is applied to all shares outstanding prior to the split or dividend and to the beginning-of-period weighted average shares. A stock split or stock dividend adjustment is not applied to any shares issued or repurchased after the split or dividend date.
Describe dilutive vs. antidilutive securities, what kind of securities are these and why are they called dilutive/antidilutive?
Dilutive securities are stock options, warrants, convertible debt, or convertible preferred stock that would decrease EPS if exercised or converted to common stock.
Antidilutive securities are stock options, warrants, convertible debt, or convertible preferred stock that would increase EPS if exercised or converted to common stock.
Diluted EPS equation
Diluted EPS =
Numerator: (Net Income - Pref. Divs + Conv. Pref Divs + (Conv. Debt Interest)(1-t))
Denominator: (Weighted avg. shares + shares from conv. pref shares + shares from conv. debt + shares issuable from stock options)
When are stock options/warrants considered dilutive?
Stock options and warrants are dilutive only when their exercise prices are less than the average market price of the stock over the year.
What is the tresury stock method, pertaining to options/warrants as dilutive securities?
The treasury stock method assumes that the funds received by the company from the exercise of the options would be used to hypothetically purchase shares of the company’s common stock in the market at the average market price.
The net increase in the number of shares outstanding (the adjustment to the denominator) is the number of shares created by exercising the options less the number of shares hypothetically repurchased with the proceeds of exercise.
ex:
Number of common shares created if the options are exercised: 100,000 shares
Cash inflow if the options are exercised ($15/share)(100,000): $1,500,000
Number of shares that can be purchased with these funds is: $1,500,000 / $20 (this is the avg. price) : 75,000 shares
Net increase in common shares outstanding from the exercise of the stock options (100,000 – 75,000) = 25,000 shares
How to calculate the net increase in common shares from the potential exercise of stock options or warrants
A quick way to calculate the net increase in common shares from the potential exercise of stock options or warrants when the exercise price is less than the average market price is:
[AMP – EP / AMP]×N
where:
AMP=average market price over the year
EP=exercise price of the options or warrants
N=number of common shares that the options and warrants can be converted into
