Look in your notes, the If Converted method.
The calculation of diluted EPS assumes anyone who could convert does so for it to come to
the convertible preferred or convertible bonds.
Starts with computations just discussed which is called basic.
For convertible securities, the following adjustments are made.
In the numerator, earnings are increased by dividends or after-tax interest that would
not have been due if securities had been converted.
Dividends or after-tax interest, the denominator shares are increased by the additional number
of common shares that would have been outstanding if they had been converted.
The convertible preferred, assume they've been converted at the beginning of the period
or at time of issuance whichever is later, no weighted is required.
That's an important point, that we're going to include it as of either at the beginning
of the year, because you assume they could have converted all year, or if they were issued
in the middle of the year, then just take half of it, because that's the earliest time,
that they could have converted.
Again, that's an important point as far as when they are converting.
We look at when they converted, the beginning of the year or time of issuance if later.
In the calculation results in an EPS number which is higher, then the security is antidilutive
and not included in the reported EPS.
To determine whether or not an item is antidilutive, each item is considered separately in sequence
from most to least dilutive.
One would normally consider options and ones first.
We go in order, "Is this dilutive?"
"No."
"Is this dilutive?"
"Yes."
"Is this dilutive?"
And so on and so on.
You'll see here, net income and now I'm making the adjustment for number two preferred dividends
not net of tax or interest expense saved net of tax.
Those numbers are included there and then the denominator, the bottom, that would be
the number of shares convertible securities converted into for both preferred and convertible
not weighted.
We�re not weighting them, don't average them up, that would be for the whole year.
All right, let's say for example I had bonds.
Let's say I've got a bond, face value is 10 million bucks.
Let's say the interest rate is 6 percent that's $600,000.
$600,000 is the interest that I would be paying.
Let's say these bonds are convertible into 300,000 share of common stock.
They are convertible into 300,000 shares of common stock.
Now, I've got this $600,000 of interest.
If you convert, what happens?
If you convert, I save $600,000.
If you convert, what happens is, I owe you $300,000 of shares of stock.
That's what's going to happen.
If you convert, I have to give you $600,000.
I have 600,000 of interest saved, and it's convertible into 300,000 shares of common
stock.
That's what's happening if you convert.
In looking at that, those are the options.
Now if I have $600,000 of extra money, what's going to happen?
I've got to pay the government taxes.
Let's say your tax rate is 40 percent.
One minus .4, that's six times six is 360.
I would have 360 extra money net of tax to add the numerator but I would have to give
up 300,000 shares of common stock.
If we just look at this, what's 360 over 300?
It's like $1.20.
It's like $1.20 per share extra that I have to give away.
If basic earnings per share is a dollar, would you give up $1.20 for a dollar?
No, that's antidilutive.
If earnings per share was four dollars, if you converted, everybody gets a little less,
okay.
You can see here the difference between the two so in the numerator over here, I would
add back plus 360 in the denominator plus 300.
That would go on the numerator versus the denominator.
If for example we had earnings per share, and let's say before this calculation I had
400...
Let's come back over here.
Let's say, this was $400,000 and this was 100,000 shares that would give me 400 over
100 is four dollars a share.
That's basic.
Now if you convert, what would happen?
If you convert, what would happen is, I would have the 400, plus I'd have an extra $360,000
but I had 100, I gave out another 100 shares, that gives me 760 over 200, which let's just
say is what?
Something under $3.80 a share let's say, I'm just pulling that number out of my whatever.
It's less than four, that's dilutive.
Because it was 400 at 100 is four dollars.
It went from four down, that's dilutive.
Everyone see that?
That's how you look at it to see is it dilutive?
This is important.
Even if they never convert, it doesn't matter.
Could they?
Yes.
Is it economically advantageous?
Yes.
Then do we include it?
Yes we do.
Again, in looking at that, that's the calculation, that's what we're adding.
In the numerator, you add the preferred dividends, not net of tax, bond interest, net of tax.
In the bottom the number of shares that they converted into.
That's what we're adding in this calculation, that's what we're adding in these number in
order to see.