Question

Assuming the firm that you are analyzing has $125 million in face value of convertible debt with a stated interest rate of 5%, interests are paid annually, a 5-year maturity and a market value of $140 million. If the firm has a bond rating of B and the interest rate on B-rated straight bond is 10%. Estimate the equity portion of the convertible debt. A. $28.67 million B. $33.37 million C. $38.69 million 9. You have decided to re-classify operating leases as financing expense for your company, which of the following would you NOT expect to happen? A. Depreciation will increase B. Book value of asset will increase C. Book value of equity will increase

Answer 1

Q8. Answer is C. $38.69million

Part A
Year-end	Proceeds Category	Value	Discounting Rate at 10%	Discounted Value
1	Interest (Face Value x 5%)	6.25	0.9091	5.68
2	Interest (Face Value x 5%)	6.25	0.8264	5.17
3	Interest (Face Value x 5%)	6.25	0.7513	4.70
4	Interest (Face Value x 5%)	6.25	0.6830	4.27
5	Interest (Face Value x 5%)	6.25	0.6209	3.88
5	Face Value	125	0.6209	77.62
Present Value of Convertible Bond			A	101.31
Total Proceeds from Issue of Bond			B	140.00
Equity Portion of Convertible Bond			B - A	38.69

Q9. Answer is C. Book Value of equity will increase.

On conversion of an operating lease into a finance lease, you are essentially converting the lease into an asset and hence depreciation will also begin impacting your P&L account. However, equity will not have an impact in this regard as only a liability will be created against the asset.