Let’s say a company has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $5 each – what is its fully diluted equity value?

Its basic equity value is $1,000 (100 * $10 = $1,000). To calculate the dilutive effect of the options, first you note that the options are all “in-the-money” – their exercise price is less than the current share price.

When these options are exercised, there will be 10 new shares created – so the share count is now 110 rather than 100.

However, that doesn’t tell the whole story. In order to exercise the options, we had to “pay” the company $5 for each option (the exercise price).

As a result, it now has $50 in additional cash, which it now uses to buy back 5 of the new shares we created.

So the fully diluted share count is 105, and the fully diluted equity value is $1,050.