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K plc has in issue a 10% convertible loan. The loan was issued 4 years ago. It has a life of 10 years and will be redeemed at a discount of 5% or can be converted into 18 shares on the same date. The company’s current share price is worth $5 and is expected to grow at 4% p.a. The loan has a current market value of $80 ex int. Corporate tax is 30%
Calculate the cost of debtPlease I want explanation to the following about the question above:
1. What is the effect of the 4 years ago in answering the question.
2. The impact of redeemable at discount.The only relevance of the fact that it was issued 4 years ago is that there are only 6 years left before it is converted or redeemed.
The impact of the discount is that investors will have the choice in 6 years time of receiving cash of $95 for every $100 nominal value, or instead to take 18 shares. The market value of the debt will be based on what they currently expect that they will do.
This is all explained in my free lectures on convertible debt.
The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
Please I had the following and I’d like you to check for me.
Conversion options:
1. Shares = 18*(5*1.04^6) = $113.88
2. Cash = $95So, the Principal will be $113.88
Market value (MV) ex int = $80, given in the question.Interest after tax = (100*10%)*(1-0.30) = $7
Please, after checking the above work for me, now I have the MV, Interest and Principal.
The kd of Convertible debt is the IRR.
The loan was issued 4 years ago and has 6 years left. So, when discounting, how many years should I use for the MV, Interest and Principal?Why are you attempting a question for which you do not have an answer? You should be using a Revision Kit from one of the ACCA approved publishers – they have answers and explanations!!
You need to calculate the IRR of the following flows:
0. MV (80)
1-6. Int 7 p.a.
6. Conversion 113.88
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