Dilution Deep Dive

Step 1: Treasury Stock Method — Stock Options

Net New Shares (Options) = 8.0m − (8.0m × $20.00 / $32.00) = 8.0m − 5.0m = 3.0m

The treasury stock method assumes the company collects the $160.0m in option exercise proceeds (8.0m × $20.00) and immediately uses that cash to buy back shares at the current market price, which is why only the net shares — not the gross option count — count as dilution. All 8.0m options are in-the-money here since the $20.00 strike sits below the $32.00 share price, so all of them are included; out-of-the-money options would be excluded entirely.

Step 2: Treasury Stock Method — RSUs

Net New Shares (RSUs) = 3.0m − ($24.0m / $32.00) = 3.0m − 0.75m = 2.25m

RSUs carry no exercise price, so without an offset they would add the full 3.0m shares to the diluted count. GAAP instead treats the unrecognized (unamortized) stock compensation expense as a hypothetical repurchase fund — the same treasury-stock logic as options, just with unrecognized comp expense standing in for exercise proceeds. That softens the dilution to 2.25m net new shares.

Step 3: If-Converted Test — Convertible Notes

Where: Coupon Rate = 4.0%, Face Value = $150.0m, Tax Rate = 25.0%, Conversion Price = $25.00.

Shares from Conversion = $150.0m / $25.00 = 6.0m

After-Tax Interest Saved = $150.0m × 4.0% × (1 − 25.0%) = $6.0m × 0.75 = $4.5m

Cost per Incremental Share = $4.5m / 6.0m = $0.75

Using basic net income of $180.0m and 100.0m basic shares, basic EPS = $1.80. Since the $0.75 cost per incremental share is lower than the $1.80 basic EPS, converting the notes would lower EPS — the definition of dilutive — so the if-converted method applies and the notes are included in the diluted count.

Step 4: Fully Diluted Share Count

Diluted Shares = 100.0m (basic) + 3.0m (options) + 2.25m (RSUs) + 6.0m (convertible notes) = 111.25m

This is the fully diluted share count used as the denominator for diluted EPS, and it's also the share count that would be used for a diluted equity value per share in a merger model or comp set.

Step 5: Diluted EPS and the Dilution Impact

Diluted Net Income = $180.0m + $4.5m (after-tax interest add-back for the now-converted notes) = $184.5m

Diluted EPS = $184.5m / 111.25m = $1.66

Compared to Basic EPS of $1.80, that's a $0.14 reduction, or roughly 7.8% dilution. Diluted EPS is the figure analysts and interviewers actually care about — it reflects the real per-share earnings power once every security that could convert into stock is accounted for, and it's the number that flows into P/E multiples and accretion/dilution analysis.

Final Results

• Net New Shares from Options: 3.0m
• Net New Shares from RSUs: 2.25m
• Shares from Convertible Notes: 6.0m
• Fully Diluted Share Count: 111.25m
• Diluted EPS: $1.66 (vs. $1.80 basic, ~7.8% dilution)

This diluted share count and EPS figure feed directly into equity value per share, P/E-based comps, and M&A accretion/dilution analysis, where understating dilution overstates how attractive a deal or a stock really looks.

Would you like to explore how this changes if the options were out-of-the-money, or if the convertible notes had turned out to be anti-dilutive instead?