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Stumbled across this question and have no idea how to answer. Please can anyone help? @johnmoffat
Alpha limited has issued convertible loan notes with a nominal value of $100 and a coupon rate of 11%, payable yearly. $100 of the loan notes can be converted into 40 ordinary shares in 3 years time. Notes not converted can be redeemed at $110. What is the current market value for $100 of the loan notes if investors require a pre-tax return on 10% and if the value of the ordinary shares on conversion day is £3.50?
Guidance would be hugely appreciated. I’m struggling with convertible market values.
first step,
we have to find out whether the investor will convert or not.
for one $100 loan note he can convert to 40 ordinary shares.
value of 40 ordinary shares=40*3.5=140
now, compare 140 with redemption value which is $110.
$140 is higher, so investor will chose to convert.second step,
it is to find discounted value of cash flows.
the discount factor =10%, since that is invetors required return.PV of interest =11*2.487=27.357
PV of redemption=140*0.751=105.14
NPV=$132.497remember,
market value of any security , it is NPV of returns discounted at investor’s expected rate of return(theorectically).Superstar! I had it up to the point of the PV of redemption where I plumped for £110 instead of £140. Totally get this now, thanks!
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