Question

when a company has stock options and warrants in the capital structure, the method of computing diluted EPS is slightly different. This method is Treasury Stock method. Can you describe,what this method is? Why do you think the exercise price of the warrant or option is important here.

Answer 1

The treasury stock method is used in the computation of the net increase in outstanding shares when in-the-money options and warrants have to be exercised. Treasury Stock Method makes an assumption that the warrant and option are exercised at the beginning of the year (or date of issue in case it is later) and the proceeds from the exercise price of warrant and option are used in the purchasing of common stock for the treasury. Upon exercise of the warrant or option, the company receives the proceed amount computed as: Exercise price of the option * No. of shares issued to holders of the warrant or option. The proceeds from the exercise of warrants and options will be used by the company to buy back common shares computed at average market price for the year. The net change in the outstanding shares is number of issued shares to holders of the warrants or options minus the number of shares acquired from the market. The exercise price of the warrant or option is significant because if it is lesser compared to the stock's market price, dilution occurs.