The very first step is to calculate Basic EPS which is NI-PD/WACSO (weighted avg common stock outstanding).EPS would be diluted any time the denominator > numerator. There are 3 ways the denominator could increase and make the EPS diluted:
1) Options – 1st step,Dilutive if, Avg mkt price > Exercise Price.
if the above condition is satisfied you calculate the Additional shares that need to be added to the denominator using:
#CS – # Repo, where #Repo = (#CS*#options*Exercise Price)/Avg Mkt Price. Be careful you have to subtract this resultant number from the #CS and then add it to the denominator.
2) Convertible securities (Bonds) – 2 changes happen in here, 1 – you add the interest expense to the numerator which is (Face value*%*1-Tax rate) and 2 the number of bonds converted to the CS are added to the denominator.
3) Convertible securities (Preferred Stock) – 2 changes happen in here, 1 – you add the PD to the numerator and number of PS converted to CS are added to denominator.
Now questions on this could be as easy as tell if the diluted EPS is Dilutive (in the money) or Anti-Dilutive
1) Options – Dilutive if (Avg Mkt price>Exercise Price
2) and 3) – Bonds and PS – Diluted EPS < Basic EPS
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