How do you calculate basic EPS versus diluted EPS?

EPS is one of the most heavily tested formulas in CFA Level I. Let me walk through both calculations step by step.

Basic EPS:

Basic EPS = (Net Income - Preferred Dividends) / Weighted Average Common Shares Outstanding

The numerator is earnings available to common shareholders. If the company has cumulative preferred stock, subtract the preferred dividend regardless of whether it was declared. For non-cumulative preferred, subtract only dividends actually declared.

Diluted EPS:

Diluted EPS assumes that all dilutive potentially dilutive securities are converted or exercised. The key potentially dilutive securities are:

• Stock options and warrants (treasury stock method)
• Convertible bonds (if-converted method)
• Convertible preferred stock (if-converted method)

Worked Example:

Mapleton Corp reports for 2026:

• Net income: $6,000,000
• Preferred dividends: $400,000 (non-convertible)
• Weighted average shares: 2,000,000
• Stock options: 100,000 options with exercise price $30; average market price $50
• Convertible bonds: $5,000,000 face, 6% coupon, convertible into 200,000 shares. Tax rate = 25%

Step 1 — Basic EPS:

Basic EPS = ($6,000,000 - $400,000) / 2,000,000 = $2.80

Step 2 — Options (Treasury Stock Method):

• Proceeds from exercise = 100,000 x $30 = $3,000,000
• Shares repurchased at market = $3,000,000 / $50 = 60,000
• Incremental shares = 100,000 - 60,000 = 40,000
• No numerator adjustment (options do not affect income)

Step 3 — Convertible Bonds (If-Converted Method):

• Interest saved = $5,000,000 x 6% = $300,000
• Tax on interest = $300,000 x 25% = $75,000
• After-tax interest savings = $300,000 - $75,000 = $225,000 (add to numerator)
• Additional shares = 200,000 (add to denominator)

Step 4 — Calculate Diluted EPS:

Diluted EPS = $5,825,000 / 2,240,000 = $2.60

Since $2.60 < $2.80, the convertible bonds are dilutive and should be included. If including a security would increase EPS, it is anti-dilutive and must be excluded (more on this in the anti-dilutive securities topic).

Exam tip: Always check whether each security is dilutive by comparing the incremental EPS (additional income / additional shares) to basic EPS. Include securities in order from most dilutive to least dilutive.

Practice more EPS calculations in our CFA Level I question bank.