Fully Diluted Shares & the Treasury Stock Method
Options and warrants add shares - but the cash raised buys some back. The Treasury Stock Method nets the two.
- ✓Apply the Treasury Stock Method to options and warrants
- ✓Explain why the impact is always (slightly) dilutive
- ✓Compute fully diluted shares from basic shares
In-the-money options and warrants will be exercised, adding shares. But exercising them hands cash to the company (holders pay the strike). The Treasury Stock Method (TSM) assumes that cash is used to buy back stock at the market price - so only the net new shares dilute.
- Cash proceeds = in-the-money options × weighted-average strike price.
- Shares repurchased = proceeds ÷ current share price.
- Net new shares = options exercised - shares repurchased.
- = basic shares + net new shares (+ convertibles).
- •Current share price: $15.00
- •Basic shares: 100mm
- •In-the-money options: 5mm at a $12.00 weighted-avg strike
- 1.Cash proceeds from exercise
- 2.Shares repurchased at market
- 3.Net new shares
- 4.Fully diluted shares
= 101mm. The 5mm options only added 1mm net shares, because the $60mm of strike proceeds bought back 4mm shares.
Since options are only exercised when the strike is below the market price, the cash they raise always buys back fewer shares than were issued. Net effect: always dilutive, but keeps it modest. Out-of-the-money options are ignored entirely.
Price $20, basic shares 50mm, in-the-money options 4mm at a $10 strike. Fully diluted shares under TSM: