Question

In: Finance

On a firm's income statement, you likely will see two entries for earnings per share (EPS):...

On a firm's income statement, you likely will see two entries for earnings per share (EPS): basic and diluted EPS. Basic EPS is the firm's net income available to shareholders divided by the number of shares of common stock.

However, while common shares are definite claims of an owner's equity, unexercised stock options, convertible debt and preferred stock, and warrants represent potential claims on an owner's equity. If they are exercised or converted, the number of common shares may increase. The hang is the percentage difference between the number of shares and the potential number of shares.

The diluted EPS is the net income available to common shareholders divided by the number of common shares if all options, convertibles, and warrants are exercised or converted.

Check Your Understanding

A firm is reporting net income available to common shareholders of $21.25 million. The firm has 45 million common shares outstanding and has no convertible preferred stock or debt. However, if all stock options and warrants were exercised, the firm would have 50 million common shares.

Basic EPS =     
Diluted EPS =     

Solutions

Expert Solution

Calculating Basic EPS

Basic EPS is calculated by dividing net income available to common shareholders divided by number of common shares outstanding

Net income available to common shareholders = $21.25 million

Current number of common shares outstanding = 45 million

Basic EPS = Net income available to common shareholders / Current number of common shares outstanding

Basic EPS = 21.25 million / 45 million = $0.4722

Hence Basic EPS = $0.4722

Calculating Diluted EPS

Basic EPS is calculated by dividing net income available to common shareholders divided by total number of common shares outstanding if all potential dilutive financial instruments like options and warrants are exercised.

Net income available to common shareholders = $21.25 million

Number of common shares outstanding if dilutive instruments like stock options & warrants are exercised= 50 million

Diluted EPS = Net income available to common shareholders / Number of common shares outstanding if dilutive instruments like stock options & warrants are exercised

Diluted EPS = 21.25 million / 50 million = $0.425

Hence Diluted EPS = $ 0.425


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