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ACCA Strategic Professional · Strategic Business Reporting (International) · Financial instruments

On 1 January 20X1 Hale issues 1,000 convertible bonds at $1,000 each, redeemable at par after 3 years. The coupon is 4% payable annually in arrears. The market rate for similar non-convertible debt is 7%. The present value of $1 at 7% is 0.9346 (year 1), 0.8734 (year 2) and 0.8163 (year 3), so the 3-year annuity factor is 2.6243. What is the equity component at initial recognition (to the nearest $000)?

The equity component is about $79,000. The liability is the present value of interest of $40,000 a year plus $1 million principal at 7%, which is roughly $921,000. Deducting this from the $1 million proceeds leaves the residual equity component of approximately $79,000.

  1. A$79,000Correct
  2. B$1,000,000
  3. C$921,000
  4. D$40,000

Explanation

Liability = interest 40,000 x 2.6243 = 104,972 plus principal 1,000,000 x 0.8163 = 816,300, giving 921,272 (about $921,000). Equity = 1,000,000 - 921,272 = 78,728, about $79,000. The $921,000 option is the liability, not the equity component.

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