Treasury Stock Method: Definition, Formula, Example
The treasury stock method is a financial tool used to calculate the potential dilution of earnings per share (EPS) that could occur from the exercise of stock options or warrants. It is commonly used by companies to determine the impact of these potential transactions on their financial statements.
The formula for the treasury stock method is as follows:
- Calculate the number of additional shares that could be purchased with the proceeds from the exercise of stock options or warrants.
- Add the number of additional shares to the weighted average number of shares outstanding.
- Calculate the hypothetical diluted EPS by dividing the net income available to common shareholders by the new total number of shares.
Here is an example to illustrate how the treasury stock method works:
- Company XYZ has 1,000,000 shares of common stock outstanding.
- There are 100,000 stock options outstanding, with an exercise price of $10 per share.
- The average market price of Company XYZ’s stock during the period is $15 per share.
- The net income available to common shareholders is $1,000,000.
Using the treasury stock method:
- Add the additional shares to the weighted average number of shares outstanding: 1,000,000 shares + 500,000 additional shares = 1,500,000 total shares.
- Calculate the hypothetical diluted EPS: $1,000,000 net income / 1,500,000 total shares = $0.67 diluted EPS.
By using the treasury stock method, Company XYZ can assess the potential impact of the exercise of stock options on its EPS. This information is important for investors and analysts in evaluating the financial performance and potential future earnings of the company.
What is the Treasury Stock Method?
The Treasury Stock Method is a financial tool used to calculate the potential impact of stock options and other dilutive securities on a company’s earnings per share (EPS). It is commonly used by companies to determine the number of additional shares that would be outstanding if all dilutive securities were exercised or converted into common stock.
Treasury Stock Method Formula
The treasury stock method is a way to calculate the potential dilution of earnings per share (EPS) that could occur from the exercise of stock options or warrants. It is commonly used by companies to determine the impact of these potential exercises on their financial statements.
Formula
The formula for the treasury stock method is:
Adjusted Weighted Average Number of Shares Outstanding = Basic Weighted Average Number of Shares Outstanding + (Number of Shares from Exercise of Stock Options or Warrants * Dilution Factor)
The dilution factor is calculated as:
The basic weighted average number of shares outstanding is the average number of shares outstanding during the reporting period, excluding any potential shares from the exercise of stock options or warrants.
The number of shares from the exercise of stock options or warrants is the number of shares that would be issued if all outstanding options or warrants were exercised.
The average market price per share is the average trading price of the company’s stock during the reporting period.
Example
Let’s say a company has a basic weighted average number of shares outstanding of 1,000,000, an exercise price per share of $10, and an average market price per share of $20. It also has 100,000 stock options outstanding.
The dilution factor would be calculated as:
The number of shares from the exercise of stock options would be:
Number of Shares from Exercise of Stock Options = 100,000
Using the treasury stock method formula, the adjusted weighted average number of shares outstanding would be:
Adjusted Weighted Average Number of Shares Outstanding = 1,000,000 + (100,000 * 0.5) = 1,050,000
By using the treasury stock method, the company can calculate the potential dilution of EPS and make more informed decisions regarding stock options or warrants.
Treasury Stock Method Example
Let’s take a look at an example to understand how the treasury stock method works. Suppose a company has 100,000 stock options outstanding with an exercise price of $10 per share. The current market price of the company’s stock is $15 per share.
Using the treasury stock method, we can calculate the potential dilution of earnings per share (EPS) if all the stock options were exercised. The formula for the treasury stock method is:
| Step | Description | Calculation |
|---|---|---|
| 1 | Number of shares to be issued | |
| 2 | Number of shares to be repurchased | Number of shares to be issued / Market price per share |
| 3 | Net increase in shares outstanding |
In our example, the calculation would be as follows:
Step 2: Number of shares to be repurchased = 500,000 / $15 = 33,333.33
Therefore, if all the stock options were exercised, the company would need to issue 500,000 shares and repurchase 33,333.33 shares, resulting in a net increase of 466,666.67 shares outstanding.
By using the treasury stock method, companies can calculate the potential dilution of EPS and make informed decisions regarding stock option grants and their impact on shareholder value.
Treasury Stock Method Example
The treasury stock method is a way to calculate the potential dilution of earnings per share (EPS) that could occur from the exercise of stock options or warrants. It assumes that the proceeds from the exercise of these options or warrants are used to repurchase shares of the company’s stock in the open market.
Let’s illustrate the treasury stock method with an example:
Company XYZ
Company XYZ has 1,000,000 shares of common stock outstanding. It also has 100,000 stock options outstanding, with an exercise price of $10 per share. The average market price of Company XYZ’s stock during the year is $15 per share.
To calculate the potential dilution of EPS, we need to determine the number of additional shares that would be outstanding if all the stock options were exercised. We do this by applying the treasury stock method.
The treasury stock method formula is:
Therefore, if all the stock options were exercised, Company XYZ would have 1,033,333 shares outstanding.
Now, let’s calculate the diluted EPS:
Assuming Company XYZ has a net income of $1,000,000 and no preferred dividends, and the weighted average number of shares is 1,000,000, the diluted EPS would be:
This means that if all the stock options were exercised, the diluted EPS would be $0.96 per share, compared to the basic EPS of $1.00 per share.
The treasury stock method is an important tool for investors and analysts to assess the potential impact of stock options and warrants on a company’s EPS. It helps them understand the potential dilution of earnings and make more informed investment decisions.
Emily Bibb simplifies finance through bestselling books and articles, bridging complex concepts for everyday understanding. Engaging audiences via social media, she shares insights for financial success. Active in seminars and philanthropy, Bibb aims to create a more financially informed society, driven by her passion for empowering others.