Diluted EPS would decrease when potential common shares are outstanding because:

Diluted EPS would decrease when potential common shares are outstanding because:

• A. Net income decreases
• B. There is no effect
• C. Denominator increases
• D. Tax rate changes

Answer: (C)

Diluted EPS reflects the possibility that there could be more common shares outstanding if options, warrants, or convertibles are exercised or converted. When those potential shares exist, the denominator—the weighted-average number of shares—rises. With net income unchanged (ignoring adjustments that some instruments may require), increasing the number of shares lowers earnings per share, so diluted EPS decreases. For example, if net income is 100 and there are 20 basic shares, basic EPS is 5. If potential shares add 5 more shares, the diluted denominator becomes 25, and diluted EPS becomes 4. The other options don’t capture this mechanism: net income would not automatically decrease due to potential shares, and tax-rate changes aren’t the driver of dilution here.

Diluted EPS reflects the possibility that there could be more common shares outstanding if options, warrants, or convertibles are exercised or converted. When those potential shares exist, the denominator—the weighted-average number of shares—rises. With net income unchanged (ignoring adjustments that some instruments may require), increasing the number of shares lowers earnings per share, so diluted EPS decreases.

For example, if net income is 100 and there are 20 basic shares, basic EPS is 5. If potential shares add 5 more shares, the diluted denominator becomes 25, and diluted EPS becomes 4. The other options don’t capture this mechanism: net income would not automatically decrease due to potential shares, and tax-rate changes aren’t the driver of dilution here.