Hemvik Pharma can borrow Rs 1,000 crore at 9% or issue a 2% convertible at a 30% premium. Compare EPS under each, find the share price at which conversion makes sense, and say what Hemvik is really selling.

The convertible gives EPS of about Rs 7.85 even fully diluted, against Rs 7.33 with straight debt, but Hemvik pays for that with a call option on its shares. Holders convert above Rs 520, into 1.923 crore shares. Valued as a 9% bond, the convertible is worth Rs 728 crore, so about Rs 272 crore of the Rs 1,000 crore raised is the price of the option. It is cheap money only if the shares do not rise much.

Straight debt: Rs 1,000 crore at 9% is Rs 90 crore of interest, Rs 67.5 crore after tax, so net income falls to Rs 732.5 crore and EPS to Rs 7.325. Convertible, basic: Rs 20 crore of coupon, Rs 15 crore after tax, EPS Rs 7.850. Diluted, use the if-converted methodFor diluted EPS, assume the bond has been converted: add back its after-tax interest to earnings and add the conversion shares to the share count.: add the Rs 15 crore back and add 1.923 crore shares, Rs 1,000 crore divided by the Rs 520 conversion price. Diluted EPS is Rs 7.849, still about 7% above straight debt.

One accounting caveat a strong candidate adds: under Ind AS and IFRS a convertible is usually split into a debt part and an equity part, and the debt part carries interest close to the 9% market rate. Reported interest is then about Rs 65 crore, not Rs 20 crore, and the EPS advantage shrinks to about Rs 7.51. Confirm the treatment against the current standard and the instrument's terms.

Holders get either Rs 1,000 crore back or 1.923 crore shares. At maturity they convert whenever the share price is above Rs 520, the conversion price, Rs 400 plus the 30% premium. Below that they take the cash. So Hemvik's shares must rise 30% in five years, about 5.4% a year, before conversion is worth anything at maturity, and every rupee above Rs 520 is a rupee per share that goes to the bondholders rather than Hemvik's existing owners.

A bond plus a call option on its own shares. Think of a landlord who charges a low rent but gives the tenant the right to buy the flat at today's price plus 30%. Value the convertible as a plain 9% bond and it is worth Rs 728 crore, the bond floorWhat a convertible would be worth with no conversion right: its coupons and principal discounted at the issuer’s straight borrowing rate.; investors pay Rs 1,000 crore, so they are paying about Rs 272 crore for the option. The low coupon is not a gift; it is the option premium, received as interest saved over five years.

So close with the judgement. A convertible suits an issuer whose management thinks the shares will rise modestly, or which values today's lower interest bill and is willing to share upside it cannot be sure of. If management expects the shares to rise sharply, straight debt is cheaper in the end, because it keeps the upside for existing shareholders. Investors buying the convertible are taking the opposite view, which is why pricing, the premium and the coupon, is a negotiation over the value of that option.