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- This topic has 7 replies, 2 voices, and was last updated 8 years ago by MikeLittle.
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- February 3, 2016 at 8:40 pm #299159
Good Evening,
I am stuck on the following question and hope you can help.
My question is, when calculating the repayment in year 3, is the ‘0.75’ derived from the present value interest rate for year 3 and if so, why? If not, where does this 0.75 come from?(Prepare of P&L, B/S, and changes in Equity to 31 march x6. Equity shares of 50 cents each = $56m)
The 8% $30m convertible loan note was issued on 1 april x5 at par.
Interest is payable annually in arrears on 31 march each year. The loan note is redeemable at par on 31 march x8 or convertible into equity shares at the option of the loan note holders on the basis of 30 equity shares for each $100 of loan note. The Finance Director has calculated that to issue an equivalent loan note without the conversion rights it would have to pay an interest rate of 10% per annum to attract investors.The present value of the $1 receivable at the end of each year based on the discount rates of 8% and 10 % are:
8%:
Year 1 – 0.93%
Year 2 – 0.86%
Year 3 – 0.79%10%
Year 1 – 0.91%
Year 2 – 0.83%
Year 3 – 0.75%Answer:
As this is a convertible loan note it has to be split between debt and equity:
Interest years 1-3 (2400 x (0.91 + 0.83 + 0.75) = $5,976
Repayment year 3 (30,000 x 0.75) = $22,500
Liability component (5,976 + 22500) = $28,476
Equity Component = $1,524 ( I assume this is calculated thus 30m loan notes less 28,476, as my text book doesn’t tell me).
Cash received (28,476 + 1,524) = $30,000Liability component = $28,476
Interest (28,476 x 10%) = $2,848
Less interest paid = ($2,400)
Balance as at 31.3.x6 = $28,924I know this may seem like a pretty straightforward question, but as the answer doesn’t tell you where the ‘0.75’ comes from, i’d rather not assume.
Thank you for your help.
SimoneFebruary 4, 2016 at 7:32 am #299192Hi Simone
Yes, you guessed correctly, twice!
The .75 is the year 3 discount factor and is applied to the repayment of the loan as well as included as part of the present value of the interest expenses.
The equity element is arrived at by deducting the present value of the loan element from the $30,000 to leave you with equity of $1,524
Ok?
February 6, 2016 at 8:57 am #299453Yes, Thank you very much!
February 6, 2016 at 9:48 am #299459You’re welcome
February 6, 2016 at 10:07 am #299461Hi Mike,
Sorry but I’ve just tried to do a similar question and I got the answer wrong.
I don’t actually understand this as much as i thought I did.
Why are we calculating interest on top of interest: 30m x 8% = 2,400 x interest again = $5976?
Not only that, but the 0.75 we included included to get 5976, will be added in again once the loan is redeemable.
To top it off, an additional 10% will be paid on top of all the other interest payable.
I’m totally confused… I feel like I should just accept thats the way it is rather than trying to understand why, but I if I am asked a slightly different question in the exam, i may not be able to answer it.
February 6, 2016 at 10:59 am #299463This line that you have typed in your original post is the calculation of 3 years’ worth of interest at $2,400 each year
Interest years 1-3 (2400 x (0.91 + 0.83 + 0.75) = $5,976
It could just as easily have been set out as:
$2,400 x .91 = $2,184
$2,400 x .83 = $1,992
$2,400 x .75 = $1,800Total $5,976
The repayment of the debt is in 3 years’ time so is discounted by the 3rd year discount factor of .75 so $30,000 x .75 = $22,500
That, added to the $5,976, gives a total debt element of $28,476 so equity element must be the difference between that amount and the $30,000
Is that any better?
February 6, 2016 at 11:24 am #299464Why is interest calculated on top of interest?
February 6, 2016 at 11:44 am #299466Where is interest calculated on interest?
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