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ACCA Applied Skills · Financial Management · Sources of finance and their relative costs

Vexa Co has a convertible loan note, nominal value $100, 4% coupon, redeemable in 4 years at par or convertible into 25 shares. The current share price is $3.20 and is expected to grow at 5% a year. What is the expected conversion value per loan note at the end of year 4, and should the holder convert?

Conversion value is 25 shares times the year-4 share price of $3.20 grown at 5%, which is $3.89, giving $97.24. This is below the $100 redemption value, so the holder would take redemption rather than convert.

  1. A$80.00; do not convert, take $100 redemption
  2. B$97.24; do not convert, take $100 redemptionCorrect
  3. C$97.24; convert
  4. D$100.00; indifferent

Explanation

Future share price = 3.20 x 1.05^4 = 3.20 x 1.21551 = 3.8896. Conversion value = 25 x 3.8896 = $97.24. Since $97.24 is below the $100 redemption value, the holder redeems. The $80 option ignores growth.

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