Chapter 16

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Why do companies make preferred stocks and bonds convertible?

It increases the marketability of the securities
When a bond or preferred stock is converted, it creates more shares of common stock and is called "dilutive"
Indicates the income earned by each share of common stock

Earnings per share (EPS)

Can be calculated for each component of income
Capital structure that only has common stock

Simple capital structure
Capital structure that has potentially dilutive securities such as convertible securities, options, warrants or other rights

Complex structure
Formula for EPS

EPS= (Net income less preferred dividends) / weighted average # of shares outstanding
Formula for diluted EPS

NI less pref dividends + Bond Int expense (1-tax rate)

divided by

weighted average # of o/s + c/s equivalent + options + warrants
Formula for determining the c/s equivalent of stock options

(Mkt price - Exercise price)/Mkt price

multiplied by

the # of stock options

If it is a negative #, no one will exercise the option
How do you determine if a security is antidilutive?

Calculate basic EPS

Calculate diluted EPS assuming the security is converted

If diluted EPS > basic EPS, the security is antidilutive