CFA Practice Question

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CFA Practice Question

Assume that the exercise price of an option is $10 and the average market price of the stock is $13. Assuming 999 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the diluted EPS?

A. 768
B. 206
C. 231
Correct Answer: C

(999)(10) = 9,990
9,990/13 = 768
999 - 768 = 231

User Contributed Comments 14

User Comment
kalps 999-[(10 * 999)/13]
blumonster don't understand. shldn't it be just 768?
Gina no, we are looking for the difference, not the proportion, ie 10 : 13 = 768 : 999. alternatively, you could have calculated (999*3)/13=231
katybo (13-10) / 13 * 999 = 231
mchu treasury stock method..
epizi Easy!option exercise you have 768 stocks in the markets at current price.So the firm has to add additional 231 stocks to satisfy the option holders.
MattyBo Read carefully. Question is for added shares.
Kogelet Treasury stock method

http://www.fool.com/research/2000/features001012.htm
gazelle There is a quick way to calculate it:
Nx[(AMP-EP)/AMP]
where: AMP= Average market price over the year
EP= exercise price of the options or warrants
N= # of common shares that the options & warrants can be converted into.
cslau83 999* 10 = 9990 <--This is money being raised from the exercise of options by holders.
9990/13 = 768 <---- this is the number of shares company can buy back form the money raised from the exercise.
999-768 = 231 <--- net increase in stock after buyback.
Saxonomy 999 options @ $10 strike price = $9990
Option holders' purchasing power.

--Let's get the spending--

(*A*) $9990/$13 = 768 shares
Number of shares option holders will have if they bought shares at market price.

(*B*) $9990/$10 = 999 shares
Number of shares option holders will have if they bought shares at exercise price.

EPS already reflects purchasing at market price (everyday stock market activity). But purchasing at the $10 discount enables the option holder to purchase more shares @ $10/share. These additional shares that all 999 option holders will now own is (*B*) minus (*A*).
Saxonomy I'm not that smart, by the way. Writing this out helps me understand it.
jonan203 nice example saxonomy!
birdperson basically, as i see it, the option holders are entitled to 999 shares of stock. with the $10 exercise price and $13 market price the firm can but 768 shares with the proceeds of the options being exercised. to make the option holders whole, the firm has to issue the remaining shares (231) using treasury stock
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