Question

The 8% $30 million convertible loan note was issued on 1 April, 2010 at par. Interest is payable annually in arrears on 31 March each year.
The loan note is redeemable at par on 31 March, 2013 or convertible into equity shares at the option of the loan note holders on the basis
of 30 equity shares for each $100 of loan note. The company’s finance director has calculated that to issue an equivalent loan note without
the conversion rights it would have to pay an interest rate of 10% per annum to attract investors.
The present value of $1 receivable at the end of each year, based on discount rates of 8% and 10% are:
8% 10%
End of year 1 0·93 0·91
2 0·86 0·83
3 0·79 0·75
What value should appear as the interest charge for the year ended 31 March, 201

Answer 1

This is a case of compound financial instrument having a debt and an equity component.

Outflow in 2011 = $ 30,000,000 * 8% = $ 2,400,000

Outflow in 2012 = $ 30,000,000 * 8% = $ 2,400,000

Outflow in 2012 = $ 30,000,000 +( 30,000,000 * 8%) =$ 30,000,000 + $ 2,400,000

                                                                            = $ 32,400,000

Calculation of Liability Component

Year ended 31 March	Outflow $	Discount Rate @ 10%	Present Value $
2011	2,400,000	0.91	2,184,000
2012	2,400,000	0.83	1,992,000
2013	32,400,000	0.75	24,300,000
Liability Component			28,476,000

Value of Equity Component = Proceeds of issue - Liability component

                                         = $ 30,000,000 - $ 28,476,000

                                         = $ 1,524,000

Interest Charge for the Year = $ 28,476,000 * 10%

                                        = $ 2,847,600