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(i) Triage Co issued 400,000 $100 6% convertible loan notes on 1 April 20X5. Interest is payable annually in arrears on 31 March each year. The loans can be converted to equity shares on the basis of 20 shares for each $100 loan note on 31 March 20X8 or redeemed at par for cash on the same date. An equivalent loan without the conversion rights would have required an interest rate of 8%.
The present value of $1 receivable at the end of each year, based on discount rates of 6% and 8%, are: 6% 8%
End of year 1 0·94 0·93
2 0·89 0·86
3 0·84 0·79The question in Sept 16 mock asks, to work out the diluted EPS,
This is the answer at the back:
The maximum additional shares on conversion is 8 million (40,000 x 20/100), giving total shares of 58 million. The loan interest ‘saved’ is $2·418m (3,023 (from (w (i)) above x 80% (i.e. after tax)), giving adjusted earnings of $16·745m (14,327 + 2,418).The shares i’ve managed to work out, but i cant seem to understand the workings for the earnings.
Ok, here’s an extract from the answer
“6% convertible loan notes
The convertible loan notes are a compound financial instrument having a debt and an equity component which must both be quantified and accounted for separately:
Year ended 31 March
20X6 20X7 20X8
Debt componentoutflow
$’000
2,400 .93 2,232
2,400 .86 2,064
42,400 .79 33,496Giving a total present value of 37,792
These present values of the cost of financing the debt represent the ‘debt element’ of this compound financial instrument and the balance between this figure of 37,792 and the proceeds of issue ($40,000) represents the equity element of this financial instrument
So the double entry to record the issue of this mixed instrument will be:
Dr Cash $40,000
Cr Preference shares $37,792
Cr Equity $2,208The finance cost of servicing this debt doe to the preference shareholders in this first year will be 8% of $37,792 = $3,023,000 and this will be taxed at 20% to leave a net figure of $2,419
And that’s where the $2,419 comes from
Better?
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