Bhanu Limited has issued 50,000; 10% convertible bonds of 100 each with a maturity period of 5 years. At the maturity, the bondholders will have an…

CA Intermediate · Financial Management and Strategic Management · MTP · May 2025
Bhanu Limited has issued 50,000; 10% convertible bonds of 100 each with a maturity period of 5 years. At the maturity, the bondholders will have an option to convert the bonds into the equity shares in the ratio of 1:4 (i.e 4 equity shares for each debenture). The equity shares of Bhanu Limited are listed and are currently traded at 30 each and historically the growth of the company's share has been 5% per annum over the years. Of the total number of convertible bonds issued, 75% opt in for converting their bonds to the common stock at an agreed price which shall be at 5% premium to the intrinsic price at that point in time. However, the investors need to hold the shares for at least 2 years from the date of conversion.

Suggested Answer and Working Notes:

(A) Approximation Method: (i) Calculation of Cost of Bonds - 75% Opting for the conversion Value of equity shares at the end of 5th year will be calculated using the concept of time value of money. FV = PV (1 + r) n = 30 (1 + 0.05) 5 = 38.29 Consideration Value (Agreed Price) = 38.29 + 5% premium = 40.20 for each equity share Each bond holder will receive 4 equity shares for each bond converted. ∴ that each bond holder will receive on conversion would be, 40.20 x 4 = 160.80 So, RV = 160.80, NP = 100, Int = 10, n = 5 years Cost of Bonds (Kd) = I(1-t)+ (RV-NP) n (RV+NP) 2 ∴ Kd = 10(1-0.25)+ (160.8-100) 5 (160.8+100) 2 = 15.08% (ii) Calculation of Cost of Bonds - Not Opting for the conversion RV = 100 + 25% (Premium) = 125 Add: Redemption cost = (125 x 2%) = 2.5 Gross RV = 127.50 Cost of Bonds (Kd) = I(1-t)+ (RV-NP) n (RV+NP) 2 ∴ Kd = 10(1-0.25)+ (127.5-100) 5 (127.5+100) 2 ∴ Kd = 11.43% (B) Yield To Maturity (YTM) Method: (i) Calculation of Cost of Bonds - 75% Opting for the conversion Year Cash Flows (₹) DF @ 10% Present Value (₹) DF @ 18% Present Value (₹) 0 (100) 1.000 (100) 1.000 (100) 1 7.5 0.909 6.818 0.847 6.353 2 7.5 0.826 6.195 0.718 5.385 3 7.5 0.751 5.633 0.609 4.568 4 7.5 0.683 5.123 0.515 3.863 5 7.5 + 160.80 0.621 104.514 0.437 73.547 NPV 28.283 - 6.284 YTM (IRR) = L + NPV L NPV L -NPV H -(H-L) H = Higher rate = 18% L = Lower rate = 10% ∴ IRR = 10+ 28.283 28.283 – (-6.284) -(18-10) Kd = 16.54% (ii) Calculation of Cost of Bonds - Not Opting for the conversion Year Cash Flows (₹) DF @ 10% Present Value (₹) DF @ 15% Present Value (₹) 0 (100) 1.000 (100) 1.000 (100) 1 7.5 0.909 6.818 0.87 6.525 2 7.5 0.826 6.195 0.756 5.67 3 7.5 0.751 5.633 0.658 4.935 4 7.5 0.683 5.123 0.572 4.29 5 7.5 + 127.50 0.621 83.835 0.497 67.095 NPV 7.604 -11.485 YTM (IRR) = L + NPV L NPV L -NPV H -(H-L) H = Higher rate = 15% L = Lower rate = 10% ∴ IRR = 10+ 7.604 7.604-(-11.485) -(15-10) Kd = 12%

Topics: Part-A: Financial Management

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