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Sir, there is a question called BAR Co (Dec 2011 – requirement b) where I have few questions related to this.
1) Since the bonds are being bought back by Bar Co at their market value of $112·50 per bond rather than their nominal value of $100 per bond BUT isn’t this unfavourable that we redeem the bond at $100 BUT buy back bond at the market price of $112.50 which is actually we are paying more when we buy back bond so why are we doing that!?
2) Bar Co has raised $90m from the rights shares issue to pay off its debt which means that we have to repay the debtholders $80m nominal value of bond (which is actually repaid at maturity to bondholders) and $10m excess goes in the company’s retained profit?
3) We are seeing how much interest do we save after redeeming the bond at $80m of nominal value and after repaying what effect it has on ratios such as EPS & PE ratio.
4) BUT there is no calculation regarding buy back bond at its market value of $112.50 even though the question states to evaluate that as well?
5) How many ratios we can calculate to see the increase in the shareholder’s wealth? In order to see the effect of rights issue is TERP & PE ratio. While the effect of redeeming the bond can be calculated from EPS and PE ratio.
Can you please correct my statements if I am at fault…
1. The are buying back the bonds so as to have to pay less interest in the future (and therefore have more available for dividends). If they want to cancel the bonds then they will have to pay the market value – there is no other way that they can cancel them and save the interest,
2. The excess over the nominal value reduces the retained earnings.
3. Yes 🙂
4. The question asks if it is financially acceptable to shareholders if we buy back the bonds. All we need is to know how much interest is save by buying them back, and the answer does calculate this.
5. For part (b), to know if it financially acceptable to shareholders we need to estimate what will happen to the MV of the sales, and the question makes it clear that we are to use a PE valuation. We do not need other ratios (apart from those specifically asked for in part (c) ),
These statements are regarding the above points:
1) Is it correct that SOFP is showing that Bar co has $125m long-term liability which means that the company has currently in debt of $125m and they are paying 8% interest p.a. Therefore, Bar Co is having 1.25m of units that they have bought of bond $100 nominal value which would be equal to the value of bond $125m (1.25m units x $100)
2) I don’t understand that you said excess over nominal value reduces retained earnings; Isn’t that correct that if we have raised $90m from rights issue that we will use to repay bondholders of $80m therefore, the difference will be $10m which is the excess money that we have raised from shareholders so where this $10m would go?
4) We are paying 8% interest annually which is $10m interest p.a. and if we cancel the bond (i.e. repaying the bondholders) that means we will save $6.4m interest every year and this would reduce our interest to $3.6m. So my question is that what is this $3.6m interest that we are paying now since we already repaid bondholders?
5) Is that also correct that if we buy back bond on market price of $112.50 this means that every unit that the company is ready to borrow would be calculated (let’s say if we have 1.25m units we are ready to borrow just like in the question) it would be 1.25m units x $112.5 = $140.625m in SOFP?
Sorry to ask again maybe it seems a bit silly questions. BUT I couldn’t understand these things & to know them better I need your help. Thanks again 🙂
1 Bar had issued 1.25M bond each of which has a nominal value of $100. When they buy back the bonds and cancel them then they will be paying the current market value of $112.50 for each bond.
2. When they make the rights issue then they will be issuing 15M shares at $6 each, and so will receive $90M. The nominal value of the shares issued is $15M which goes to share capital and the excess of $75M goes to the share premium account. This is Paper FA (was F3) but is not relevant for this question.
Buying back the bonds is separate. We pay $90M to buy back bonds with a nominal value of $80M. The nominal value of the bonds on the SOFP reduces by $80M and the other $10M reduces the retained earnings. Again, this is Paper FA but is not relevant here because you are not asked to produce a SOFP.
4. The $3.6M is the interest payable on the bonds that have not been repaid. There are bonds remaining (and not cancelled) with a nominal value of $45M and the interest on them (8% x $45M = $3.6M) is still payable.
5. I do not understand. They are not borrowing any more. At the moment they have long term borrowing with a nominal value of $125M. When they buy back the bonds and cancel them then they will only then have long term borrowing with a nominal value of 125 – 80 = $45M. On the SOFP bonds always appear at their nominal value, not at their market value (per Paper FA).
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