ExpertMedium2 marksMultiple Choice
ACCA · Question 13 · Estimating the Cost of Capital
Section A
WindForce Inc has issued convertible green bonds. The current market value is $105 per $100 nominal value. The bonds pay annual interest of 5% and mature in 4 years. At maturity, investors can either redeem at par or convert into 20 ordinary shares. The current share price is $4.50 and is expected to grow at 6% per year. The corporate tax rate is 20%.
What is the expected conversion value of the bond at maturity?
Section A
WindForce Inc has issued convertible green bonds. The current market value is $105 per $100 nominal value. The bonds pay annual interest of 5% and mature in 4 years. At maturity, investors can either redeem at par or convert into 20 ordinary shares. The current share price is $4.50 and is expected to grow at 6% per year. The corporate tax rate is 20%.
What is the expected conversion value of the bond at maturity?
Answer options:
A.
$90.00
B.
$100.00
C.
$113.62
D.
$120.00
How to approach this question
First, calculate the expected share price in 4 years using the compound growth formula: Current Price * (1 + growth rate)^n. Then multiply this future share price by the number of shares offered on conversion.
Full Answer
C.$113.62✓ Correct
To find the expected conversion value, we must forecast the share price at the date of maturity.
Future share price = Current price * (1 + g)^n
Future share price = $4.50 * (1 + 0.06)^4 = $4.50 * 1.26247 = $5.681
Conversion value = Number of shares * Future share price
Conversion value = 20 * $5.681 = $113.62.
Since $113.62 > $100 (par value), investors are expected to convert.
Common mistakes
Calculating the current conversion value instead of the future conversion value, or applying the tax rate to the share price.
Practice the full ACCA FM — Financial Management Practice Exam 6
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