Securities Industry Essentials (SIE) ExamUnderstanding Products and Their RisksHard
A company has 5,000,000 shares of common stock outstanding and 2,000,000 shares of convertible preferred stock. Each preferred share is convertible into 2 shares of common stock. If all preferred shares are converted, what would be the fully diluted number of common shares outstanding?
- A5,000,000 shares
- B7,000,000 shares
- C9,000,000 shares
- D4,000,000 shares
Show answer & explanationAnswer & explanation
Correct answer: C. 9,000,000 shares
To calculate the fully diluted number of common shares outstanding, you add the currently outstanding common shares to the number of common shares that would result from the conversion of all convertible securities. In this case, 2,000,000 preferred shares * 2 common shares/preferred share = 4,000,000 new common shares. Adding this to the existing 5,000,000 common shares results in 9,000,000 fully diluted common shares.
Why the other options are wrong
- A. This is only the current number of common shares outstanding, not fully diluted.
- B. This incorrectly adds the number of preferred shares directly to common shares, without accounting for the conversion ratio.
- D. This is only the number of common shares resulting from the conversion of preferred stock, not the total fully diluted shares.
Fully Diluted Shares Outstanding
The total number of common shares that would be outstanding if all convertible securities (e.g., convertible bonds, convertible preferred stock, stock options, warrants) were converted into common stock.
- Used in calculating diluted Earnings Per Share (EPS).
- Includes all potential common shares.
- Represents the maximum possible number of shares.
Memory trick: Dilution Adds All Potential Shares.