Discuss the concept of simple vs. complex capital structures and how it relates to the reporting of earnings per share.
Simple structure:
A capital structure is said to be simple if there is no security that can be potentially converted into common stock. Such securities are called dilutive securities.
Complex structure:
If the capital structure has dilutive securities (like convertible bonds, employee stock option, preferred stock conversion, etc.) then the structure becomes complex.
Earnings per share (EPS):
EPS = (NI – PD) / Number of common shares outstanding
Net income = NI; Preferred dividends = PD
In case of complex capital structure EPS becomes lower than simple capital structure. It happens because the number of common shares increases on that time, because other securities are converted to common shares. Since there is an increase in denominator, EPS of complex structure becomes lower.
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