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Darlga Co is partly financed by 7% loan notes which are redeemable at their nominal value of $1,000 per loan note
in eight years’ time. Alternatively, the loan notes are convertible after seven years into 110 ordinary shares of
Darlga Co per loan note. The ordinary shares of Darlga Co are currently trading at $6·50 per share on an ex dividend
basis. The current cost of debt of the convertible loan notes is 8%.
Required:
(a) Justifying any assumptions which you make, calculate the current market value of the loan notes of
Darlga Co, using future share price increases of:
(i) 4% per year;
(ii) 6% per yearHere they have calculated an expected MV at the end of seven years by multiplying 1070 to 0.962( 8% Df for yr 1). I did not understand why so. Please clarify
At the end of 7 years they have the choice of either converting into shares, or waiting 1 more year (because the redemption is after 8 years) in which case they will receive an extra 1,070 (the redemption plus another years interest).
In order to compare the value of shares in 7 years time, and 1,070 in an extra year, the 1,070 is discounted for 1 year at 8% (so to get a value in 7 years time).
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