How do convertible bonds affect a company's enterprise value when they are in the money?

How do convertible bonds affect a company's enterprise value when they are in the money?

• A. Counted as part of the company's debt
• B. Counted as permanent equity on the balance sheet
• C. Considered as dilution to the equity value
• D. Ignored in financial assessments

Answer: (C)

When convertible bonds are in the money, they can be converted into equity at a predetermined price. This conversion feature allows bondholders to exchange their bonds for shares of the company's stock, which can lead to an increase in the number of outstanding shares. When these convertible bonds are converted into equity, the ownership stake of existing shareholders is diluted, as the total number of shares increases without a corresponding increase in the company's assets. This dilution can reduce the value of existing shares and thereby impact the company's overall equity value. Consequently, convertible bonds are considered a potential source of dilution to equity value, which is why the selected answer reflects the idea that their conversion could affect the value perceived by existing equity investors. This distinction is crucial in financial assessments, particularly when evaluating the potential consequences of convertible bonds being exercised, which can influence a company's overall market capitalization and enterprise value.

When convertible bonds are in the money, they can be converted into equity at a predetermined price. This conversion feature allows bondholders to exchange their bonds for shares of the company's stock, which can lead to an increase in the number of outstanding shares.

When these convertible bonds are converted into equity, the ownership stake of existing shareholders is diluted, as the total number of shares increases without a corresponding increase in the company's assets. This dilution can reduce the value of existing shares and thereby impact the company's overall equity value.

Consequently, convertible bonds are considered a potential source of dilution to equity value, which is why the selected answer reflects the idea that their conversion could affect the value perceived by existing equity investors. This distinction is crucial in financial assessments, particularly when evaluating the potential consequences of convertible bonds being exercised, which can influence a company's overall market capitalization and enterprise value.