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Treasury Stock Method (Formula, Examples) | Effect of Stock Options on EPS - YouTube
Channel: WallStreetMojo
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hello everyone welcome to the channel of
Wallstreetmojo. Watch the video till
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the end and also if you are new to this
channel then you can subscribe us by
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clicking the bell icon. Friends today we are going to study tutorial on Treasury
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stock method this is completely epicness
guideline completely a pigness guide
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employee stock options I mean our very
complex column the options granted by
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the companies as a part of the
remuneration package I mean it's
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difficult when when stock options are
exercised in large quantities it can
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have a significant impact on the total
numbers of the outstanding shares
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thereby diluting the EPS negatively
affecting the valuation of the firm. So
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to comply with the gap the dilutive
impact the stock options and warrants
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must be captured using the Treasury
stock method. This tutorial discusses the
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nuts and the bolts of Treasury stock
method like what are the employee stock
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options how do you employ stock options
affect earning per share
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what is Treasury stock method? Treasury
stock method any examples. Treasury stock
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with colgate example ok. Now let's
start with the first what are the
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employee stock options or ESO. ESO is
option granted to company employees
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that carries the right but not the
obligation to buy the promised number of
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shares at a predetermined price please
note that the ESO are different from the
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exchange traded options are as they are
not traded and they don't come with the
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put component also please note that the
predetermined price is also called the
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strike price or exercise price. Have
a look at this option table from the
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Colgate's 2014 10 k this table provides
a detail of Colgate's outstanding stock
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options along with its weighted average
exercise price how to employ stock
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options affect earning per share. See
stock options can be exercised if the
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market price is greater than the
exercise price or the strike price that
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is called in the money. Once these stock
options are exercised the company issues
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shares to the option holders this in
turn increases the total number of the
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outstanding shares. Earning per share which is known as net profit divide by
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the number of shares outstanding
decreases as
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denominator increases. In addition you
should also be aware of the two
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important employee option terminologies
option outstanding, an option exercisable.
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Option outstanding is total number of
the options issued by the company but
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not necessarily wasted. These option may be in the money or out the money. In
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Colgate
options outstanding about $42.902.
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options exercisable. Options that are vested as
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of now this option again could be in the
in the money or out of the money for
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Colgate the option exercisable
are 24.946
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million. Let's take the example of
Colgate 2014 10K which is the filings
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as noted above that there are 24.946
million employees.
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Stock options that are exercisable for
considering the effect of the dilution
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we only take the option that our
exercisable
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and note the option outstanding as many
of the option outstanding may
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not have been vested. Let us compare the
average exercise price of $46
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with the current market
price of the Colgate. As of the closing
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of the June 13 2016 Colgate was trading
close enough to 76.67
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since the market price is greater
than the excess price
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all 24.946
million are in the money and therefore
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will increase the total number of the
shares outstanding will be 24.946.
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Now the basic EPA for EPS of Colgate.The
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net income of 2014 of Colgate
was close enough to 180
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million.The basic shares were 9.5.1 million. So the
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formula of basically EPS is the net
income that was 2180
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million divided by the 915
that is the number of shares which will
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give us 2.38 dollar. Now what is the impact
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of the stock option in the diluted EPS
of colgate that is a Treasury stock
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method not used. The net income of
Colgate was let's take this in a excel
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format and learn things very well let's
say the net income
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of the Colgate in 2014 this year
talking over 2014 was 2180
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million everything is a million. The
outstanding shares that we are talking
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is 915.1 million plus 24.916
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that will give us 940.046 million so the diluted EPS is
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going to be is equal to 2180
divided by 940.046.
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As you can see that the EPS
decreased from 2.38 to
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2.31 due to the impact of
these stock options if the amount of the
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stock options issued by the company is
large it can have a significant impact
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on the EPS of the company thereby
negatively affecting the valuation of
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the firm. Do have a look at the p/e ratio
for the further details hence in order
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to minimize the impact of the EPS
dilution we use the treasury stock
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method. Now let us now try and understand following questions what is done
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with the option proceeds company
receives the funds from the employees on
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exercise of the option second can this
options proceed used proceeds that are
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used in the same way and then in some
way to reduce the impact of the dilution
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read the Treasury stock method what is
Treasury stock? The Treasury stock
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method assumes that the options and the
warrants are exercised at the beginning of
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the year or at the date of the issue if
later and the proceed from the exercised
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options and the warrants are used to
purchase the common stock of the
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treasury. There is no adjustments to the
net income in the numerator upon
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exercise of the options or the warrant
the company receives the following
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amount of the proceeds exercise price
the option X number into
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number of shares issued to the holder of
the options or warrants. The company will
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then use the proceeds from the exercise of options and warrants to buy back the
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common shares at the average market
price of the year. The net change in the
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number of shares outstanding is the
number of shares issued to the holders
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of the option or the warrant less the
number of shares acquired from the
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market. Now as you can see below are the three steps primary steps used for
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treasury stock method. First in the money
options and warrants are assumed to be
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excised second they proceed from the
exercise assumed to purchase common
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stock at the average market price during
the period.Third the incremental shares
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that is the number of shares that issued
is less the number of shares that are
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assumed to be purchased will be included
in the denominator so treasury stock
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formula for net increase in the number
of shares is going to be net increase is
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going to be in the money option
less the shares repurchase used using
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hypothetical funds. If the exercise price
of the option or warrant is lower than
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the market price of the stock dilution
occurs if higher the number of the
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common shares is reduced and anti
dilutive effect occurs in the later case
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exercise is not assumed. Treasury stock
method example let's take one
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example during 2006 there was one
company called KK Enterprise okay they
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reported the net income of close enough
to 250,000 okay let's take this
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example and work on it the net income
was a close enough to 250,000 and
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had 100000 shares that is number of
shares okay. During 2006 KK Enterprise
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issued 1000 shares of 10% per
100 preferred stock outstanding. In
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addition the company has 10000
options with the strike price X of 2 per
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dollar so the strike price is 2 per
dollar okay and the current market price
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is 2.5 computed diluted EPS.
Assume the tax rate is 40% okay so this
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is the basic example let's see how
things have been calculated as you can
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see the basic EPS example the
net income 250000 divided by the
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preferred dividend 10000 okay 1000
preferred shares that is 10% par $100
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1200 into 10 percent so that 10,000 and
the common stock 100000. So the basic
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EPS comes to 2.4 because we need to
deduct preferred dividend from the net
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income now talking about the diluted EPS
denominator 1 lakh basic shares plus
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10,000 in the money options buyback
that is 102000 so net income -
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250000, preferred dividend 10000, common stock 100000 in the money 10,000 and
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shares repurchase 8,000 so company
inflow is going to be 10000 *
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2 i.e 20000 by back is 20000
divided by 2.5 okay that was a
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ratio and which will give us 8000.
So the diluted EPS comes down
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to 2.35. So let's see the
treasury stock with its colgate
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example as you can see the data over
here of the colgate consolidated
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financial statement as you can see from
the above for the year ended 2014 only
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9.2 millions were considered
instead of 24.946
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million why the difference is 24.946
millions less
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the 9.2 millions that is
15.746 million
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shares the answer lies in the colgate
10K. It mentions that diluted earning
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common share is computed using treasury stock method with this we may assume that
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15.476 may be
related to the buyback using the option
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proceeds I hope you have got the best
knowledge for the Treasury stock method
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in this particular tutorial. So that's it
for this particular topic if you have
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learned and enjoyed watching this video
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