Mae Jong Corp.issues 1,000 convertible bonds at the beginning of 2011.The bonds have a four-year term with a stated rate of interest of 6 percent, and are issued at par with a face value of €1,000 per bond (the total proceeds received from issuance of the bonds are €1,000,000) .Interest is payable annually at December 31.Each bond is convertible into 250 ordinary shares with a par value of €1.The market rate of interest on similar non-convertible debt is 9 percent.Compute the liability component of Mae Jong's convertible dent.The following present value factors are available:

Question

Quizplus · Accepted Answer

To compute the liability component of Mae Jong's convertible debt, we need to first calculate the present value of the liability portion of the bond based on the market interest rate of 9%. 
Step 1: Calculate the cash outflow for principal repayment at maturity. 
The face value of each bond is €1,000, so the total cash outflow for principal repayment is: 
1000 x 1000 = €1,000,000 
Step 2: Calculate the present value of the cash outflow for principal repayment using the present value factor for a four-year term at 9% (3.2397): 
PV of principal repayment = €1,000,000 ÷ 3.2397 = €308,880 
Step 3: Calculate the present value of the interest payments using the present value factor for an annuity of 1 at 9% for four years (3.6274): 
PV of interest payments = (0.06 x €1,000 x 1,000) x 3.6274 = €218,244 
Step 4: Add the present values of the principal repayment and interest payments to get the liability component: 
Liability component = €308,880 + €218,244 = €527,124 
Therefore, the best choice is C, €902,813 is the liability component of Mae Jong's convertible debt.