Question

1. Determine the Basic and Diluted Earnings Per Share for Company X. All necessary Information is listed below. Show your calculations. 2. In 100 words, or fewer, explain why investors should be more interested in the the Diluted EPS number than the Basic EPS number. Company X information for Diluted Shares calculations for period 201X: Earnings for Year 201X - $20 million Average Basic shares outstanding for Company X in 201X – 10 million Average Stock Price for year 201X - $6.00 Warrants to purchase common shares: - Warrants A to purchase 2 million shares ex @ $2.00 - Warrants B to purchase 3 million shares ex @ $5.00. Assume the A and B Warrants are the only additional securities outstanding (besides the basic shares) for Company X in 201X.

Answer 1

Basic EPS = Net income / Number of shares O/S = 20 MIL / 10 Mil = 2/share

A warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed price called exercise price until the expiry date.

Warrant A if exercised by warrant holders, would get 2 million shares at the price of $2 per share. Hence, the company issues 2 million new shares.

The amount received by company for that issue would simply be 2 million *2 = 4 million. Under the treasury stock method, we assume that the company repurchases it's outstanding share in the market through this cash received.

Hence, the shares bought back would be 4 million/ $6 = 666,667 Shares

Hence the total number of new share issue would be 2 million - 666,667 = 1,333,333

Similarly for Warrant B.

3 mil shares issued at 5$ = 15 Million

Number of shares Bought back from the market = 15 mil / 6 = 2,500,000

Hence, the total number of new share issue would be = 3mil - 2.5 mil = 500,000 shares

So, the total number of shares outstanding in the market now would be

10 Million + 500,000 + 1,333,333 =10,633,333

Hence the Diluted EPS would be = 20 Million / 10,633,333 = 1.88/Share

A basic EPS gives us a normal picture of the company profit allocated to each outstanding share of common stock, however The diluted EPS also considers the issues of Convertible pref shares, convertible debt, waarants, ESOP into the account for earning per share, hence it gives us the better picture if the company has a complex capital structure and hence is prefferable.