What is ‘If-Converted Method’
A technique for calculating the impact of convertible securities on the stock market if they are converted into fresh shares. In the if-converted approach, only in-the-money convertible securities (i.e., securities where the stock price is greater than the exercise price) are taken into account.
Assume for the purposes of this technique, that convertible securities are converted at the beginning of the fiscal period or at the time of issuance, whichever occurs later. The conversion ratio of the convertible securities is used to determine the number of new shares that will be issued.
Explaining ‘If-Converted Method’
Convertible debt that is converted into stock increases share dilution while simultaneously decreasing interest expenditure, which is a tax-deductible expense for a firm in the form of interest payments.
Consider the following scenario: A $20 million convertible debenture with an interest rate of 5% would result in an annual interest expenditure of $1 million for a corporation with no other debt.
This is taken into account by the if-converted approach, which adjusts earnings per share (EPS) to reflect the after-tax interest savings realized as a result of the conversion, so offsetting the dilution caused by the additional shares.
If-Converted Method FAQ
What is the if converted method?
What Is the If-Converted Method and How Does It Work? When calculating the value of convertible securities, investors utilize the if-converted approach to assume that the securities have been converted into new shares. This is accomplished by first examining the conversion ratio of the convertible security and then comparing the conversion price to the current market price of the shares being converted.
What is an as if converted basis?
It is assumed that the preferred shares have been converted into some number of common shares when assessing the right or benefit of the preferred stock under this 'as converted basis' approach. The idea of 'as converted' is fictitious in the sense that the preferred shares have not been converted in the traditional sense.
Further Reading
- The Pricing of Mismeasured EPS – papers.ssrn.com [PDF]
- The economic dilution of employee stock options: Diluted EPS for valuation and financial reporting – meridian.allenpress.com [PDF]
- Economic consequences of financial reporting changes: diluted EPS and contingent convertible securities – link.springer.com [PDF]
- Assessing the role of financial deepening in business cycles: the experience of the United Arab Emirates – www.tandfonline.com [PDF]
- A theoretical and empirical study of computing earnings per share – drum.lib.umd.edu [PDF]
- Investment and financing activity following calls of convertible bonds – www.sciencedirect.com [PDF]
