ACCA FM Syllabus B. Financial Management Environment - Convertible Debt - Past Papers ^{3 / 4}

Which of the following financial instruments will NOT be traded on a money market?

A. Commercial paper
B. Convertible loan notes
C. Treasury bills
D. Certificates of deposit

Lane Co has in issue 3% convertible loan notes which are redeemable in five years’ time at their nominal value of $100 per loan note. Alternatively, each loan note can be converted in five years’ time into 25 Lane Co ordinary shares.

The current share price of Lane Co is $3·60 per share and future share price growth is expected to be 5% per year.

The before-tax cost of debt of these loan notes is 10% and corporation tax is 30%.

What is the current market value of a Lane Co convertible loan note?

A. $82·71
B. $73·47
C. $67·26
D. $94·20

Par Co currently has the following long-term capital structure:

The 8% loan notes are convertible into eight ordinary shares per loan note in seven years’ time. If not converted, the loan notes can be redeemed on the same future date at their nominal value of $100. Par Co has a cost of debt of 9% per year.

The ordinary shares of Par Co have a nominal value of $1 per share. The current ex dividend share price of the company is $10·90 per share and share prices are expected to grow by 6% per year for the foreseeable future. The equity beta of Par Co is 1·2.

The loan notes are secured on non-current assets of Par Co and the bank loan is secured by a floating charge on the current assets of the company.

Assuming the conversion value after seven years is $126·15, what is the current market value of the 8% loan notes of Par Co?

A. $115·20
B. $109·26
C. $94·93
D. $69·00

The 8% loan notes are convertible into eight ordinary shares per loan note in seven years’ time. If not converted, the loan notes can be redeemed on the same future date at their nominal value of $100. Par Co has a cost of debt of 9% per year.

The ordinary shares of Par Co have a nominal value of $1 per share and have been traded on a large stock exchange for many years. Listed companies similar to Par Co have been recently reported to have an average price/earnings ratio of 12 times.

Required:
(a) Calculate the market price of the convertible loan notes of Par Co, commenting on whether conversion is likely. (5 marks)

Discuss the attractions to a company of convertible debt compared to a bank loan of a similar maturity as a source of finance.