ACCA Applied Skills · Financial Management · Estimating the cost of capital
Vale Co has 6% convertible loan notes of $100 nominal, redeemable at par in 3 years. Comparable non-convertible debt would yield 8% pre-tax. Discount factors at 8%: annuity years 1-3 2.5771, year 3 0.7938. What is the floor value of each loan note, ignoring tax?
The floor value is $94.84. It is the present value of $6 annual interest and $100 redemption after three years, discounted at 8%, the yield on similar non-convertible debt. The conversion option adds value above this floor.
- A$100.00
- B$94.84Correct
- C$79.38
- D$15.46
Explanation
Floor value is the present value of the interest and redemption at the straight-debt yield of 8%. That is 6 × 2.5771 + 100 × 0.7938 = 15.46 + 79.38 = $94.84. Discounting at the 6% coupon rate would give $100, which is wrong because the straight-debt yield is 8%.
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