How are convertible bonds treated in the enterprise value calculation when they are in the money vs out of the money?

How are convertible bonds treated in the enterprise value calculation when they are in the money vs out of the money?

• A. If in the money, count as debt; if out of money, count as equity.
• B. Always count convertible bonds as cash to EV.
• C. If convertible bonds are out of the money, ignore them; if in the money, count as equity.
• D. If in the money, count as dilution to equity value. If out of money, count face value of convertibles as part of debt.

Answer: (D)

Convertible bonds can turn into equity, so how they’re treated in enterprise value depends on whether conversion is currently advantageous. When the convertibles are in the money, the conversion would be exercised and the debt would effectively turn into equity, diluting existing shareholders. In EV terms you reflect this by counting the instrument as dilution to equity value rather than as debt. When they are out of the money, conversion isn’t attractive right now, so they behave like regular debt. In that case you include their face value as part of debt in the EV calculation. This matches the idea that convertible debt is a contingent claim that acts like equity if it’s likely to convert, and like debt if it isn’t.

Convertible bonds can turn into equity, so how they’re treated in enterprise value depends on whether conversion is currently advantageous.

When the convertibles are in the money, the conversion would be exercised and the debt would effectively turn into equity, diluting existing shareholders. In EV terms you reflect this by counting the instrument as dilution to equity value rather than as debt.

When they are out of the money, conversion isn’t attractive right now, so they behave like regular debt. In that case you include their face value as part of debt in the EV calculation.

This matches the idea that convertible debt is a contingent claim that acts like equity if it’s likely to convert, and like debt if it isn’t.