Forums › ACCA Forums › ACCA AFM Advanced Financial Management Forums › Please help – Coupon rate calculations
 This topic has 5 replies, 5 voices, and was last updated 5 years ago by 1603069naabadoo.

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November 19, 2012 at 8:10 am #55464Deep
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Hi.
I would appreciate if someone could explain the second part to the question mentioned below(Dec/2009)Alaska Salvage is in discussion with potential lenders about financing an ambitious fiveyear project searching for lost
gold in the central Atlantic. The company has had great success in the past with its various salvage operations and
is now quoted on the London Alternative Investment Market. The company is currently financed by 120,000 equity
shares trading at $85 per share. It needs to borrow $1·6 million and is concerned about the level of the fixed rates
being suggested by the lenders. After lengthy discussions the lenders are prepared to offer finance against a mezzanine
issue of fixed rate fiveyear notes with warrants attached. Each $10,000 note, repayable at par, would carry a warrant
for 100 equity shares at an exercise price of $90 per share. The estimated volatility of the returns on the company’s
equity is 20% and the risk free rate of interest is 5%. The company does not pay dividends to its equity investors.
You may assume that the issue of these loan notes will not influence the current value of the firm’s equity. The issue will be made at par.Required:
(a) Estimate, using BlackScholes Option Pricing Model as appropriate, the current value of each warrant to the
lender noting the assumptions that you have made in your valuation. (10 marks)
(b) Estimate the coupon rate that would be required by the lenders if they wanted a 13% rate of return on their
investment. (4 marks)
(c) Discuss the advantages and disadvantages of issuing mezzanine debt in the situation outlined in the case.CAN ANYONE PLEASE EXPLAIN THE SECOND PART OF THE QUESTION (12/09)
November 20, 2012 at 4:06 am #107845soidahmad Topics: 0
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As we know that for a redeemable debt cost of debt is given by IRR. we calculate the IRR by discounting cf’s at two different interest rate.. well here IRR is given or u can say kd(gross redemption yield) is given .wee have to calculate the cash flows so
cash flow from year 1 to 5 would be 100*coupon rate (because we receive coupon rate as cash flows so if we multiply 100 with coupon rate % we get cash flow) IT WOULD BE DISCOUNTED USING ANNUITY FACTOR because we receive 100*coupon rate for five years each year
redemption in year 5 would be 10,000(discounted using present value)
so know we have 100*coupon rate@ AF+ redemption @DF=PV
and pv in this case is how much they lend at the first place i.e 10000 but we have to deduct the value of warrants to see actual pv which would be 2241 so 100002241=7759 is effectively borrowed so back to the formula
100*coupon rate@AF+redemption@DF=7779
put AF and DF for 13% 5 year from the table and adjust the equation to get coupon rate.hope that answered the quesionNovember 20, 2012 at 7:41 am #107846Deep Topics: 4
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Hi Soidahmad,
Thanks a lot. Had the answer but could not understand it. Thanks a bunch once again.
Best of luck for your forthcoming papers.June 9, 2016 at 3:40 am #321281Jonathan Topics: 0
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Sorry, can anyone explain how the 13% was derived ? I’m still very confused on this
November 15, 2016 at 5:35 am #348986dewan Topics: 22
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Its already mentioned in the requirements of b. Required rate of return is the Kd which we normally finds out for redeemable loans by doing IRR.
November 29, 2016 at 9:13 pm #3524641603069naabadoo Topics: 0
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please can someone explain why in semblian the part a of the question has been answered using year 1of the spot yield curve and the remaining used the annual forward rate? I really don’t get it. thanks

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