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Dear Sir,
I have seen that this question has been posted before on the forums but I still do not understand. Please helpBaldie Co issues 4,000 convertible bonds on 1 January 20×2 at par. The bonds are redeemable three years later at a par value of $500 per bond, which is the nominal value.
The bonds pay interest annually in arrears at an interest rate ( based on nominal value) of 5%. Each bond can be converted at the maturity date into 30 1$ shares.The prevailing market interest rate for three year bonds that have no right of conversion is 9%
RequiredShow how convertible bond would be presented in the statement of financial position at 1 January 20×2.
Cumulative Three year annuity Factors:
5% 2.723
9% 2.531Answer:
Working: FV of equivalent non- convertible debt
PV of principal payable at end of 3 years
(4,000 x $500 = ($2m x 1/1.09)3 = 1,544,367PV of interest annuity payable annually in arrears for 3yrs
[(5% x $2m) x 2.531] = 253,100Financial Liability of Convertible bond $1,797,467 (1,544,367+253,100)
Equity = 2,000,000 – $1,797,467 = $202,533
My Answer: ( I am confused on the discounting bit)
Net proceeds = 4000 bonds *$500 = $2m
PV of Liability at Acq:
Yr1: $2m * 1/1.09
Yr2: $2m * 1/1.09^2
Yr3:$4m * 1/1.09^3Total Liability = $5.062M
Equity = (balancing figure) = 3.062mYr 1 2m x 5% / 1.09
Yr 2 2m x 5% / (1.09) ^2
Yr 3 2m x 5% / (1.09)^3
Yr 3 2m / (1.09)^3Not sure what you are doing, but don’t do it! You are trying to discount company’s future cash outflows.
🙂
Understood Sir. Much appreciated!
There is a difference of about $29 compared to the answer in the textbook. Would this lose marks if it were marked in the exam?
For clarification purposes. How would we go about subsequent measurement of the Financial liability ?
Would this be correct:Yr 1: B/f = 1,797,494.96 + Fin cost 5%: 89,874 – Cash paid: 100,000 = C/F : 1,787,368.96
Sir, I thought we calculate finance costs using the effective rate of interest. Wouldn’t it be 5% ?
”The bonds pay interest annually in arrears at an interest rate ( based on nominal value) of 5%. Each bond can be converted at the maturity date into 30 1$ shares.”
No – for convertibles:
1. Normal borrowing rate = 9 = for P&L
2. Actual rate = 5 = for cash paid.If you do it that way the CA of the liability will be 2m at end of bond’s term (I hope!)
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