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.When Mae Jong records the issuance of these bonds, how much will it credit to Share Premium-Conversion Equity? The following present value factors are available:

Question

Quizplus · Accepted Answer

To determine the amount credited to Share Premium-Conversion Equity, we need to calculate the fair value of the conversion option embedded in the bonds.

First, we need to calculate the value of the bonds as if they were non-convertible. Using the present value factors provided, we can calculate the present value of the interest and principal payments:

PV of interest payments = 60 / (1+0.09)^1 + 60 / (1+0.09)^2 + 60 / (1+0.09)^3 + 1,060 / (1+0.09)^4 = €787.47

PV of principal payment = 1,000 / (1+0.09)^4 = €683.01

Total PV of cash flows = € 1,470.48

Next, we need to calculate the value of the conversion option. We can do this by subtracting the value of the non-convertible bonds from the value of the convertible bonds.

PV of convertible bond cash flows = 60 / (1+0.06)^1 + 60 / (1+0.06)^2 + 60 / (1+0.06)^3 + 1,060 / (1+0.06)^4 = €800.78

Value of conversion option = € 800.78 - € 1,470.48 = -€ 669.70

Since the conversion option has a negative value (i.e. it detracts from the value of the bond), we credit the amount to Share Premium-Conversion Equity. The amount credited is € 669.70 x 1,000 = €97,187. Therefore, the correct answer is B) €97,187.