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Hi John,
I have a question on convertible bonds.
Dofu agrees to provide leveraged finance for an MBO in the form of (vi) $20m 6% convertible bond which can be converted into shares in 5 years.In the answer i see that when calculating gearing we assume that book value of this bond is $20m each year.
But shouldn’t we account convertible bonds initially at discounted amount, with the balancing figure relating to equity as option to convert (totalling together to $20m)? And unwind the discount each year through PL. In fact it would change the gearing calculation.Am i wrong somewhere, or it is just our assumption of stable $20m debt, as we do not given the cost of debt?
A little bit confused.Thank you in advance for answer,
Nick
If this were a financial accounting exam, then you might well be correct (I honestly do not know because I do not teach financial accounts 🙂 ).
However, whether or not you are correct, then certainly in the AFM exam we never do anything like unwinding a discount. For AFM the book value will stay as per the amount borrowed of $20m (unless obviously there are repayments as with the 8% bond).
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