CFA Practice Question

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CFA Practice Question

What is the effect on the basic earnings per share (EPS) equation when the proceeds received from the exercise of a warrant must be used to retire debt?
A. The denominator must be adjusted, but not the numerator.
B. The numerator and denominator must be adjusted.
C. No adjustment is necessary.
Explanation: The exercise of the warrant increases the weighted number of shares in the denominator. The retirement of debt will increase net income in the numerator since the firm will pay less interest.

User Contributed Comments 8

User Comment
cutehinano I picked C. It's asking for basic PS...
koushaku Wouldn't warrants only effect Dilutive EPS?? The question asks for Basic EPS....
akurt Actually, its semantics. The warrants ARE being exercised (no hypothetical). With the issue of the warrants, # of shares increase (denominator) and the interest expense will go down, increasing income (numerator). I missed the meaning of the second part.
johnsk agree with akurt: this is not a hypothetical situation but something that happened!
murli Yes. impact on EPS from the Exercise Not from Hypothetical exercise of warrants.
boddunah if warrants are there and exercised. its not simple capital structure. am i right?
hoyleng warrant used to retire debt should adjust the numerator as well. damm..didnt read it properly
endurance Excellent question

Simple or complex capital structure? We can't say. But the question is simple, what are the basic eps after the exercise of warrants. After the exercise (and when can't say when it happened)the amount of outstanding shares increases.

Lower debt decreases interest expense and net income increases - so both the lines in the formula is affected
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