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Lane Co has in issue 3% convertible loan notes which are redeemable in five years’ time at their nominal value of $100 per loan note. Alternatively, each loan note can be converted in five years’ time into 25 Lane Co ordinary shares.
The current share price of Lane Co is $3.60 per share and future share price growth is expected to be 5% per year.
The before-tax cost of debt of these loan notes is 10% and corporation tax is 30%.
What is the current market value of a Lane Co convertible loan note?
Answer has been calculated like this. Discounting at 10%, loan note value = (3 x 3.791) (114.87 x 0.621) = $82.71. The interest has not been adjusted for tax. Why ?It is investors who determine that market value by discounting the future receipts at their required rate of return. Their expected receipts and required rate of return are not affected by company tax and therefore we use the pre-tax figures.
Tax is only relevant when calculating the cost to the company,This is commonly asked in the exam, which is why I stress this point in my lectures.
The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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