High PG Ltd is a production company with an average return on assets of 8.0% and
ID: 2328957 • Letter: H
Question
High PG Ltd is a production company with an average return on assets of 8.0% and an average cost of debt of 7.7%. The company needs to raise additional funds in a competitive market environment. The Balance Sheet shows the company is currently financed as follows:
Equity and Liabilities
Position AUD
Current Liabilities $ 33,033,000
Non-Current Liabilities $ 9,317,000
Total Liabilities $ 42,350,000
Share Capital $ 85,425,000
Accumulated losses $ (28,475,000)
Total equity $ 56,950,000
As the personal assistant of the CFO L. Winters, you have been asked to evaluate the following opportunities to acquire $15 million of new capital and to provide advice at the board of directors meeting on September 10th, 2018.
High PG Ltd Step-up Bond
Instrument: Step-up Bond
Issue size: AUD 15million
Coupon: 8%,10%,12% annual payment
Issue Price: 100.00% (par)
Settlement date: 01-January-2019
Maturity date: 31-December-2021
OR
High PG Ltd Convertible Bond
Instrument: Convertible Bond
Issue size: AUD 15million
Coupon: 5%, annual payment
Settlement date: 01-January-2019
Maturity date: 31-December-2021
Conversion rate: 15million $1 shares at maturity
Note: Without the conversion feature, the bond would be priced the same as the corporate Bond.
(1) Provide a short introduction.
(2) Provide and explain the journal entries for the High PG Ltd Step-up Bond from 1 January 2019 to 31 December 2021. Refer to the specific Australian accounting standards.
(3) Provide and explain the journal entries for the High PG Ltd Convertible Bond from 1 January 2019 to 31 December 2021. Refer to the specific Australian accounting standards. Assume the bond is converted at maturity.
(4) Assuming a net profit (after interest and tax) of 10 MAUD, provide a forecast of the equity and liability sections of the Balance sheet as at 31 December 2019 for each bond. Based on the effects of these different options on the financial statements of High PG Ltd, provide a recommendation to the CFO and board of directors.
Explanation / Answer
(1) Short Introduction:
The objective of a company is to increase the shareholders' wealth. In the given case, the company needs to raise the funds amounting $15 mns for a period of 3 years from the competitive market. It has 2 options for raising the fund:
(i) Step up Bond
(ii) 5% Convertible Bond
We need to evauate the two options to raise funds for new capital.
(2) Journal entries for Step up Bond:
(3) The second option is to issue 5% Convertible bonds on 1-Jan-2019, maturity after 3 years i.e. on 31-Dec-2021. The interest cost with no conversion rights (i.e. cost of debt) is 7.70% p.a. Hence, we need to separate the debt and equity component at the time of issue of bons.
Computation of Debt and Equity component of Convertible Debentures as on 1-Jan-2019
Present Value of the principle repayable after 3 years
[15,000,000*0.8005] (3rd year discounting factor @ 7.70%)
Add: Present Value of Interest [15,000,000*5%*2.5911]
(3 years cummulative discounting factor @ 7.70% p.a.
Table showing bond liability at the end of each year:
Journal entries for Convertible Bond:
(4) Evaluation of both the options:
Option 1
Step up Bond
Option 2
Convertible Bond
By looking into the above analysis, it can be seen that Option 2 yield better Net profit than the option 1. Hence, it is recommended to proceed with Option 2 i.e. raising funds using Convertible Bond. However, convertible bonds wll be more riskier form of capital than the normal bond.
Date Particulars Dr.($) Cr.($) 1-Jan-2019 Bank A/c..................Dr 15,000,000 To Bondholders A/c 15,000,000 (Being money on application received) 1-Jan-2019 Bondholders A/c......Dr. 15,000,000 To Step up Bond A/c 15,000,000 (Being the amount transferred) 31-Dec-2019 Profit and Loss A/c......Dr. 1,200,000 To Finance Cost 1,200,000 (15,000,000*8%) 31-Dec-2019 Finance Cost A/c......Dr. 1,200,000 To Bank A/c 1,200,000 (Being payment made to bond holders) 31-Dec-2020 Profit and Loss A/c.....Dr. 1,500,000 To Finance Cost 1,500,000 (15,000,000*10%) 31-Dec-2020 Finance Cost A/c.....Dr. 1,500,000 To Bank A/c 1,500,000 (Being payment made to bond holders) 31-Dec-2021 Profit and Loss A/c.....Dr. 1,800,000 To Finance Cost A/c 1,800,000 (15,000,000*12%) 31-Dec-2021 Finance Cost A/c.....Dr. 1,800,000 To Bank A/c 1,800,000 (Being payment made to bond holders) 31-Dec-2021 Step up Bond A/c....Dr. 15,000,000 To Bondholders' A/c 15,000,000 (Being liability of payment arise on maturity) 31-Dec-2021 Bondholders' A/c....Dr. 15,000,000 Bank A/c 15,000,000 (Being liability paid off)Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.