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Hello John, I’m looking at a question here which says the following:
A 9% redeemable loan note in ATV co is due to mature in 3 years time at a premium of 15% or convertible into 25 ordinary shares . Current share price is $4 expected to grow @ 10% p.a. ATV pays corp tax at 30%. RTF: What is the current mrkt value of the loan note if loan note holders require a 10% return.
The answer has the redemption value of shares as $133.10 which I got. I am confused however as to how the “premium of 15%” , “corp tax” and the “10% return” come into play for the redeemable value of the loan note as I don’t see it being used in the answer provided in the text as shown below:
Time 1-3 interest $9 DF@ 10% = 2.487 PV=22.383
Time 3 redemption $133.30 DF@ 10% = 0.751 PV=99.9581
122.3411Answer being the current mrkt value is 122.34.
Please advise.You will know from the free lectures that the market value is determined by the investors expected receipts discounted by the investors required rate of return.
That explains why discounted at 10% – it is the investors required rate of return.
Tax is always irrelevant when calculating the market value because the investor receives the full interest (tax is only relevant when calculating the cost of debt to the company, because the company gets tax relief on the interest).
On redemption date, the investor has the choice of taking cash (here or $115) or shares. Since they are expecting that the shares will be worth more than 115, the current market value is based on an expected receipt on redemption of $133.10.
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