Treasury Stock Method

The TSM calculation follows four steps. First, identify all in-the-money options and warrants — those whose exercise price is below the current stock price (out-of-the-money instruments are excluded because rational holders would not exercise them). Second, calculate the total proceeds the company would receive if all in-the-money instruments were exercised: Proceeds = Number of Options × Exercise Price. Third, determine how many shares the company could repurchase at the current market price: Shares Repurchased = Proceeds / Current Stock Price. Fourth, calculate the net incremental shares: Net Shares = Options Exercised − Shares Repurchased. Finally, diluted shares outstanding = Basic Shares + Net Incremental Shares from all dilutive instruments.

Diluted shares outstanding is the correct denominator when calculating equity value per share from the equity value bridge. If you use basic shares instead of diluted shares, you overstate the per-share value because you are ignoring the dilution from options that will almost certainly be exercised. In a football field chart or valuation summary, equity value per share = Equity Value / Diluted Shares Outstanding. The TSM is also used to calculate diluted earnings per share on the income statement, which is the metric that drives P/E ratio analysis and accretion/dilution in merger models.

Restricted Stock Units (RSUs) are treated differently from options under TSM because they have no exercise price — the full number of unvested RSUs is added to diluted shares (sometimes net of shares assumed withheld for taxes). Convertible bonds and convertible preferred stock are evaluated under the if-converted method: if conversion is dilutive (i.e., reduces EPS), the shares from conversion are added and the interest or dividend savings are added back to the numerator. In practice, bankers build an options waterfall table that groups all outstanding options by exercise price tranche, applies TSM to each in-the-money tranche separately, and sums the net incremental shares. This granularity matters because the dilutive impact varies significantly depending on how deep in-the-money each tranche is.