How is diluted EPS calculated in a model?

• A. Diluted EPS ignores potential dilutive shares.
• B. Diluted EPS is calculated using actual and potential dilutive shares, typically via the treasury stock method.
• C. Diluted EPS uses only revenue projections.
• D. Diluted EPS always equals basic EPS.

Answer: (B)

Diluted earnings per share shows what earnings per share would be if every potential dilutive security were exercised or converted. In a model, you start with the actual weighted-average shares outstanding and then add the number of shares that could be created by dilutive instruments. For options and warrants, the standard approach is the treasury stock method: assume options are exercised at the period’s price, the proceeds are used to buy back shares at the prevailing price, and the net increase in shares outstanding becomes the dilutive increment. For convertible securities, you adjust the numerator and denominator to reflect potential conversion—often using an if-converted or similar method, and you typically subtract after-tax interest or dividends from net income and add the converted shares into the denominator. The key idea is to include only those potential shares that would actually dilute earnings; anti-dilutive items are excluded. In contrast, basic EPS ignores any dilutive potential and would not capture this effect, and the option stating that diluted EPS relies only on revenue projections or that it always equals basic EPS is incorrect.