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Struggling to understand how we arrive at the answer to the following question:
Baldie Co issues 4,000 convertible bonds on 1 January 20×2 at par. The bonds are redeemable three years later at a par value of $500 per bond, which is the nominal value.
The bonds pay interest annually in arrears at an interest rate ( based on nominal value) of 5%. Each bond can be converted at the maturity date into 30 1$ shares.The prevailing market interest rate for three year bonds that have no right of conversion is 9%
RequiredShow how convertible bond would be presented in the statement of financial position at 1 January 20×2.
Cumulative Three year annuity Factors:
5% 2.723
9% 2.531Answer:
Working: FV of equivalent non- convertible debt
PV of principal payable at end of 3 years
(4,000 x $500 = ($2m x 1/1.09)3 = 1,544,367PV of interest annuity payable annually in arrears for 3yrs
[(5% x $2m) x 2.531] = 253,100Financial Liability of Convertible bond $1,797,467 (1,544,367+253,100)
Equity = 2,000,000 – $1,797,467 = $202,533
I am confused to as to why we do not show the present value of cash flows for each of the years including the amount redeemable at the end of 3 years to obtain the liability.
I am also confused as to why we do not do anything with the shares for the equity calculation.
Why has the annuity of 2.531 (9%) been used for the interest?
I see the date we are asked to report for is the 1 January 20×2, still confused – please help?
Hi,
i think your difficulties come down to the understanding of the non-SBR issue, i.e. the way in which we discount.
I’ll answer the last apart of your query first as the constant coupon interest paid is a series of constant annual cash flow, so meets the defintiion of an annuity. Instead of applying a discount rate to it each year we can apply an annuity factor to is instead. Think of it as a short cut. If you multiplied each of the annual cash flows by the discount factor and summed it up then you would get the same answer. Try it.
For your query in relation to the equity, then we do not touch the equity balance once it has been initially recognised.
For the first part of your query then this has been done. They have discounted the amount redeemable to give the 1,544,367. There are 4,000 of the $500 convertible issues and they have been discounted back by three years at 9%.
Thanks
Thank you so so much. I arrived at the answer with your guidance. Always so helpful.
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