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When we use cash raised by rights issue to redeem the debt (Bonds or Loan); This simply means that we are using equity finance by issuing rights shares to raise cash to simply put them into paying the debtholders.
In question Grenarp Co (BPP kit) where company has raised cash of $11.2m from rights issue which they want to use for redeeming Loan notes (paying the redemption value to their debtholders – ending their debt liability).
REDEEMING simply means that Grenarp Co wants to cancel Loan notes (paid full debt so they have no loan notes obligation) which will now save us the interest payments which we would be otherwise paying if we have had not cancelled the Loan notes.
BUT please correct me on this part of the question where redemption price &Nominal Value of Loan notes is calculated:
Redemption price of Loan notes = 104 x 1.05 = 109.20
Nominal Value of Loan notes = (109.20/100) x $10.9m = $10m
I have two questions here that:
We are calculating Nominal value of Loan notes because we want to see the interest that we saved now after cancelling the loan notes which we used to pay based on nominal value?Secondly, why do we take $10.9m cash raised to calculate nominal value of Loan notes?
Is that all correct or not. Please do correct me!
Thank you for your time SIR 🙂
We need the nominal value to calculate the interest that will be saved, because the interest is calculated on the nominal value.
We take the 10.9m because the question says that they net cash is used to redeem part of the loan notes. Given that they are being redeemed at $109.20 each they will redeem
10.9m / 109.20 loan notes, each with a nominal value of $100.- Topics: 44
- Replies: 26
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I understand your answer & I appreciate it. BUT I was unable to grasp few things in this question. Let me ask you in simple way?
1) Redeem the Loan notes means that company has paid the redemption value to the debtholder & now the company does not have any Non-current Liability?
[This is what I asked you previously because I could not understand the logic behind what is company trying to do]
“REDEEMING simply means that Grenarp Co wants to cancel Loan notes (paid full debt so they have no loan notes obligation) which will now save us the interest payments which we would be otherwise paying if we have had not cancelled the Loan notes”.
2) Is that correct that we arre using rights issue raised money to redeem Loan notes because we want to get rid of the debt by paying off to the debtholders.
In this case, we saved the interest that we were paying for the interest payments to our debtholders which will resdult increase in PAT?
3) How can we see the increase in the Shareholders Wealth; what ratios do I have to calculate in order to see the increase in wealth? In most times PE ratio is used to calculate the revised Share Price after the rights issue to compare with the TERP to see whether it has increased or not to decide whether it has increase shareholders wealth or not [true?]
4) Why the issue cost was deducted from the TERP calculation? Is that correct that it does not include because it is an expense which not need to be included in the total CASH RAISED to calculate TERP (new market value of share price)?
1. Redeeming means repaying. If they redeem then the liability no longer exists.
2. Yes. They want to remove the debt so that there is less interest to pay each year in the future.
3. Shareholders wealth is measured by the market value of the shares. How we calculate the MV depends on the information given in the question, but in this type of question we usually use a PE valauation.
4. The question specifically says that the issue costs will be paid out of the cash raised from the rights issue. Therefore only the balance after issue costs is used to repay the loan notes.
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