No.169 (Diluted EPS) on Volume 2 Schweser Volume 2 company, average, reported, addition, net

Spongebob

Company reported net income of $500 million and the company had 100 million common shares outstanding. In addition, it had 5 million shares of convertible preferred and 10 million outstanding warrants during the year. Each preferred share pays a dividend of $4 per share and is convertible into three common shares. Each warrant is convertible into one common share at $25 per share. The company's stock traded at an average $50 per share and the company did not declare any dividends for the year. What is diluted EPS.

a. $4
b. $4.2
c. $4.8

I thought it was b as"

500,000,000 / (100,000,000+15,000,000+5,000,000)= $4.2, but the answer is A. It subtracted $20 million from net income, which is preferred dividend. I thought I had to add back the preferred dividends as they're converted into equity.

Help please.
Thanks

Flok

I think that is a typo. I think the answer is B as well.

cyber21

Is it the net income or warrants? If you use 500 /100+15+10 (1 for 1 for each warrant)=4

Warrants should be like options, like you did it.......or so I thought

Kiakaha

yes, i have not yet taken vol 2 but usually get errors while taking q bank.

lc26mizzou

Both preferred share and warrants are dilutive.

Warrants are by no means looking anti dilutive bcoz average share price is double the exercise price and they will not add anything to the numerator.

adding warrants will decrease the EPS from 4.8 (480,000,000/100,000,000) to 4.57 (480,000,000/105,000,000)

Preffered shares are also not anti dilutive bcoz: 20,000,000/15,000,000= 1.33 EPS which is less than 4.57 thus adding preffered shares also decrease the EPS.

adding Preffered shares the EPS will be as shown above that is 4.2

elcfa, correct me if am wrong

JPSem

Gents
Not so fast. You forgot to check the anti dilutive conditions.

GAAP says that if converting leads to higher EPS, you should not include the conversion in the calculation of diluted EPS as you did in this case.

Ionutzakis

In theory, the common shares will never increase by the exact amount of convertible warrants. Warrant and option holders, more often than not, are usually required to contribute the prescribed amount if they are in the money.

In the above example, 10m warrants are convertible to 10m common shares at $25 per share - however the current average price is at $50 per share. The percentage difference between the two prices is effectively the net increase in common shares if the warrants are excercised.

A nifty way to calculate this is the following:

((ASP-EP)/ASP) x N

((50-25)/50) x 10m = 5m