## Diluted EPS
### What Are Potential Equity Shares?
Potential Equity Shares (PES) are financial instruments that entitle their holders to acquire equity shares in the future. They do not exist as equity shares today but could dilute EPS if converted.
Examples:
- Convertible Debentures
- Convertible Preference Shares
- Employee Stock Option Plans (ESOPs)
- Share Warrants (right to buy shares at a pre-determined price set on the grant date)
---
### Formula
$$\text{Diluted EPS} = \frac{\text{EAFESH} + \text{Effect of PES (Numerator adjustment)}}{\text{WANES} + \text{Effect of PES (Denominator adjustment)}}$$
Numerator adjustment (for convertible instruments):
$$\text{Savings in interest, net of tax} = \text{Face Value} \times \text{Rate} \times (1 - \text{Tax Rate})$$
Denominator adjustment:
Add the equity shares that would have been issued on conversion, time-weighted from the date of issue.
---
### Anti-Dilution Test
| Outcome | Action |
|---|
| Diluted EPS < Basic EPS | Dilutive — report Diluted EPS |
| Diluted EPS > Basic EPS | Anti-dilutive — do NOT report; Diluted EPS = Basic EPS |
> The purpose of diluted EPS is to show the worst-case scenario for equity holders. Any instrument that would increase EPS is ignored.
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### Working Note Structure (always show two WNs)
WN 1 — Adjusted Numerator (EAFESH + effect of PES)
| ₹ |
|---|
| EAFESH | x |
| Add: Interest savings net of tax | x |
| Total | x |
WN 2 — Adjusted Denominator (WANES + effect of PES)
| Shares |
|---|
| WANES | x |
| Add: Potential equity shares (time-weighted) | x |
| Total | x |
### Example 1
Illustrative Example (Full Year Conv Debs, from Page 20)
Given:
- Basic EPS = ₹10 per share (EAFESH = ₹10,00,000; WANES = 1,00,000 shares)
- 5,000 Convertible Debentures, FV ₹100, 8% interest, outstanding full year
- Each debenture converts into 10 equity shares after 5 years
- Tax Rate = 30%
WN 1:
| ₹ |
|---|
| EAFESH | 10,00,000 |
| Add: Savings in interest net of tax (5,000 × 100 × 8% × 70%) | 28,000 |
| Total | 10,28,000 |
WN 2:
| Shares |
|---|
| WANES | 1,00,000 |
| Add: Potential equity shares (5,000 × 10) | 50,000 |
| Total | 1,50,000 |
$$\text{Diluted EPS} = \frac{10{,}28{,}000}{1{,}50{,}000} = ₹6.85$$
Since ₹6.85 < ₹10 (Basic EPS) → Dilutive → Report ₹6.85 as Diluted EPS.
### Example 2
Q 11 — Dilutive (Page 22)
Given:
- EAFESH = ₹75,00,000; WANES = 10,00,000 shares
- Basic EPS = ₹7.50 per share
- Conv Debs outstanding; interest expense = ₹8,00,000 (assumed full year); Tax Rate = 30%
WN 1:
$$\text{Savings in interest net of tax} = 8{,}00{,}000 \times 70\% = 5{,}60{,}000$$
$$\text{Adjusted numerator} = 75{,}00{,}000 + 5{,}60{,}000 = 80{,}60{,}000$$
WN 2:
$$\text{Adjusted denominator} = 10{,}00{,}000 + 1{,}10{,}000 = 11{,}10{,}000$$
$$\text{Diluted EPS} = \frac{80{,}60{,}000}{11{,}10{,}000} = ₹7.26$$
Since ₹7.26 < ₹7.50 → Dilutive → Report.
### Example 3
Eg 2 (Anti-Dilutive case, Page 23)
Given:
- Basic EPS = ₹1 per share (EAFESH = ₹10,00,000; WANES = 10,00,000 shares)
- On 01/07/X1: ₹7,00,000 of 10% Conv Debs issued; convertible into 10,000 equity shares after 5 years; Tax Rate 30%
- Debs outstanding for 9 months (July to March)
WN 1:
$$\text{Interest for 9 months} = 7{,}00{,}000 \times 10\% \times \tfrac{9}{12} = 52{,}500$$
$$\text{Net of tax} = 52{,}500 \times 70\% = 36{,}750$$
$$\text{Adjusted numerator} = 10{,}00{,}000 + 36{,}750 = 10{,}36{,}750$$
WN 2:
$$\text{Potential shares (time-weighted)} = 10{,}000 \times \tfrac{9}{12} = 7{,}500$$
$$\text{Adjusted denominator} = 10{,}00{,}000 + 7{,}500 = 10{,}07{,}500$$
$$\text{Diluted EPS} = \frac{10{,}36{,}750}{10{,}07{,}500} ≈ ₹1.003$$
Since ₹1.003 > ₹1.00 (Basic EPS) → Anti-dilutive → Not reported.
Disclosed Diluted EPS = Basic EPS = ₹1.00