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Hello sir
My query relates to part (c) of the question
In this the conversion is after 7 years
redemption is after 8 yearsWhy are they comparing the conversion value of $940 to $990.82(they are calling it the expected market value). why did they calculate it like this?
I know we can’t compare comversion value with nominal value, because of time difference but what is the logic behind $990.82?Thankyou
I don’t know where you are finding this question, but there is no part (c) in the original exam question!!
(and neither do any of the figures you mention appear in parts (a) and (b) of the original exam question).
This is from Kaplan, i guess they modified it and added a part c).
This is it
c)
The dollar denominated loan notes each have a nominal value of $1000 and are convertible. As an alternative to redemption in 8 years, the loan note holders could after 7 years convert each loan note into 110 ordinary shares of Plam Co.
The ordinary shares of plam co are currently trading at $6.5 per share on ex div basis. The cost of debt of convertible loan notes is 8%.
required:
justifying any assumptions which you make, calculate the current market value of the loan notes of Plam Co, using future price increases of:
i) 4% per year
ii) 6% per yearMy problem: They have taken out an expected market value(based on redemption value of $1000 and year 8 interest payment of $70, which they have discounted to bring the value into year 7.
1070*0.926=990.82) to compare with the conversion value.
Could you provide some guidance for this?The current market value depends on what investors expect they will do with regard to conversion. i.e. will they convert to shares in 7 years or will they take cash in 8 years.
To decide what they expect they will do, they compare the value of the conversion in 7 years with the value of the cash in 7 years (which means discounting the cash amount by 1 year to get the value in 7 years).
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