- 17 Marks
FM – L2 – Q81 – Sources of finance: debt
Question
(a) Dinco Supermarket is considering acquiring a loan of GH₵300,000 from Abrempong Bank Ltd. The loan is payable in five equal annual instalments at an interest rate of 25%. Dinco Ltd has consulted you to determine their annual repayment amount and the interest thereon.
Required:
(i) Prepare a repayment schedule for Dinco indicating clearly the interest payment and the principal repayment
(ii) State THREE (3) advantages of a term loan over an overdraft facility
(b) On 1st January 20X4, Exchequers Insurance issued a 15% convertible bond quoted at GH₵123. The nominal value for each bond is GH₵100 and the conversion date for the bond is 31st December 20X9 after interest has been paid. The bond is convertible at 20 ordinary shares per GH₵100 bond. The current price per share is GH₵6.
Required:
(i) Determine the conversion rate.
(ii) Determine the conversion premium.
(iii) Comment on the possibility of bond holders converting for shares.
Answer
(a) (i) Dinco
Loan Amount (C)
Interest rate (r)
No. of years (n)
Annuity (DF)
Annual Instalment
Annuity = 1/r (1 – 1/(1+r)^n)
Annuity = 1/0.25 (1 – 1/(1.25)^3) = 2.68928
Annual instalment = C/DF = 300,000/2.68928 = 111,554.02
| Years | Bal B/d | Interest | Principal |
|---|---|---|---|
| 1 | 300,000 | 75,000 | 36,554.02 |
| 2 | 263,445.98 | 65,861.49 | 45,692.53 |
| 3 | 217,753.45 | 54,438.36 | 57,115.66 |
| 4 | 160,637.79 | 40,159.45 | 71,394.57 |
| 5 | 89,243.22 | 22,310.80 | 89,243.22 |
(ii) Advantages of term loan over overdraft
- interest charged on an overdraft is not predictable, as it depends on a variable interest rate and on the amount overdrawn on each day of the charging period
- the lender may not grant the entire overdraft amount requested as changing financial situation of the business will be taken into consideration
- overdrafts are repayable on demand, which may occur at a time when management are not ready
(b) Convertible bonds
(i) Conversion rate = conversion ratio × market price per share
Conversion ratio: GH₵100 = 20 ordinary shares
Price per share = GH₵6
Therefore: conversion rate = 20 × GH₵6 = GH₵120
(ii) Conversion premium
= current market value of coupon – current conversion value
Market value of coupon = GH₵123
Conversion value = GH₵120
Therefore: conversion premium = 123 – 120 = GH₵3
(iii) The share price is less than the bond market value. This will not be attractive to the bondholders. The share price would have to increase by at least 2.5% [(3/120) × 100] for it to be attractive to bond holders.
- Tags: Conversion Premium, Conversion Rate, Convertible bonds, Debt financing, Equity Conversion
- Level: Level 2
- Topic: Sources of finance: debt
- Uploader: Samuel Duah