Can someone explain me, I can`t understand this questions, I need a step by step:
For its fiscal year- end, Calvan Water Corporation (CWC) reported net income of $12 million and a weighted average of 2,000,000 common shares outstanding. The company paid $800,000 in preferred dividends and had 100,000 options outstanding with an average exercise price of $20. CWC’s market price over the year averaged $25 per share. CWC’s diluted EPS is closest to:
A $5.33.
B $5.54.
C $5.94.
How much money goes into the numerator of the fully diluted EPS?
How many shares go into the denominator of the fully diluted EPS?
Well Net Income according to the book formula (https://gyazo.com/aa84ec4c7eeda3c9732a199c3382852e) would be the numerator, the denominator would be more or less $2.000.000 (I got confused with this option stuff)
What’s the number?
The denominator isn’t dollars; it’s a number of shares. And whether it’s more or less than 2,000,000 is really, really important; it’s the whole point of this question.
You have to assume that the options are exercised, and that any money generated is used to buy back shares. This is known as the Treasury Stock method.
So . . . what’s the number.
Nevermind I alredy learned how to do it after understood what I had to do with the options
Diluted EPS = 11.200.000/2.020.000
Diluted EPS = $5,54
Awesome!
By the way, you’d better calculate basic EPS as well, if the diluted EPS is bigger than basic EPS, you should use basic EPS instead of Diluted EPS,in this question, the basic EPS is 5.6, so use 5.54 as diluted EPS is correct.
Also, be careful when the basic EPS is negative: the rules for when a security is dilutive and when it is antidilutive are reversed: a smaller negative EPS is antidilutive whereas a smaller positive EPS is dilutive.
Can you show me how would you calculate it in this question?
As Basic EPS = (NI - Preferred Dividends)/Weighted Average Number of Shares Outstanding
It basically ignores the options were exercised and the new shares issued?
Yes.
i dont get why the 20,000 are added in the denominator?
Are you familiar with the Treasury Stock method?
In this case, the Preferred Dividends were subtracted from the Net Income in order to calculate the Diluted EPS - because the question said that the preferred dividends were already paid.
But consider this similar question:
Q. For its fiscal year-end, Sublyme Corporation reported net income of $200 million and a weighted average of 50,000,000 common shares outstanding. There are 2,000,000 convertible preferred shares outstanding that paid an annual dividend of $5. Each preferred share is convertible into two shares of the common stock. The diluted EPS is closest to:
$3.52.
$3.65.
$3.70.
Solution: C is correct. Diluted EPS = (Net income)/(Weighted average number of shares outstanding + New common shares that would have been issued at conversion) = $200,000,000/[50,000,000 + (2,000,000 × 2)] = $3.70 The diluted EPS assumes that the preferred dividend is not paid and that the shares are converted at the beginning of the period.
Why do we assume that the dividend is not paid, when the question states explicitly that “There are 2,000,000 convertible preferred shares outstanding that paid an annual dividend of $5.”
When do you subtract preferred dividends from net income while calculating Diluted EPS, and when do you not?
That’s not the reason they’re subtracted.
They’re subtracted because they belong to the preferred shareholders, not the common shareholders, whether or not they’ve been paid.
I highlighted the answer.
I understood the 1st part.
But I’m sorry, which highlight are you referring to? I’m yet a little confused with the latter part of my question.
Take a look at the post of yours that I quoted in my post; the word convertible is highlighted.
i think the reason on why it the preferred dividnt is not taken into account it is because if the shares are being converted into common stock then the prefered dividends wouldnt be paid? and they would only need to pay common dividends for the new
If preferered are converted then they don’t exist as preferreds anymore.