Which data should be used to estimate potential dilution from stock options in diluted EPS calculations?

Which data should be used to estimate potential dilution from stock options in diluted EPS calculations?

• A. Exercisable options
• B. Vested options
• C. Options outstanding
• D. All granted options including expired

Answer: (C)

In diluted EPS calculations you want to capture all potential new shares that could be issued from options. The data you use is options outstanding. This includes all options that have been granted and are not yet exercised or expired, i.e., the rights that could still become common shares and thus potentially dilute earnings. When you estimate the dilution, you typically apply the treasury stock method: assume every option is exercised at its strike price, the company raises cash from the exercise, and that cash is used to buy back shares at the period’s average market price. The net increase in shares, equal to options outstanding minus shares repurchased, is added to the weighted-average shares to compute diluted EPS. Exercisable options would understate potential dilution because unvested options can also become dilutive in the future. Vesting options would miss the unvested portion. Including expired options would overstate dilution since they can no longer be exercised.

In diluted EPS calculations you want to capture all potential new shares that could be issued from options. The data you use is options outstanding. This includes all options that have been granted and are not yet exercised or expired, i.e., the rights that could still become common shares and thus potentially dilute earnings.

When you estimate the dilution, you typically apply the treasury stock method: assume every option is exercised at its strike price, the company raises cash from the exercise, and that cash is used to buy back shares at the period’s average market price. The net increase in shares, equal to options outstanding minus shares repurchased, is added to the weighted-average shares to compute diluted EPS.

Exercisable options would understate potential dilution because unvested options can also become dilutive in the future. Vesting options would miss the unvested portion. Including expired options would overstate dilution since they can no longer be exercised.