On page 486 of Reading 39 (2008 Curriculum), we are told that the effect on operating cash flow stemming from issuing a convertible bond is the same as that stemming from issuing bonds with warrants. The text does not elaborate or explain in detail why this is so. Can someone please explain this with a simple example?Thank you.
A convertible bond with warrants is equivalent to a Bond issued at a discount. So if we consider an example with a 1000$ par bond, 10% bond with 10 warrants @ 3$ each … @ issuance this is equal to a 97 discount bond and the T-Accounts would look like Dr Cr Cash 1000 Bond Discount 30 Bond Payable 1000 Common Stock warrants 30 If the warrants can be converted to 1 common share each of 5$ Par value at 20$ At exercise —> Common Stock warrants 30 Cash 200 (20 * 10) Common Stock 50 ( 5*10) Additional paid-in Cap, 180 (Plug)
Hi, cpk123. Thank you for your response. However, I fail to see how your response relates back to OPERATING cash flow in terms of the cash payment for interest. Please elaborate. Thank you.
bonds with warrants are accounted for as though they are bonds issued at a discount. reported liability is lower, but increases as bond discount is amortized. cash payment for interest is based on the face value * coupon rate. reported interest expense is on the market rate. so reported interest expense is lower. (bcos bond liability is lower) so CFO will be higher. (Interest expense is a deduction from CFO, hence lower interest exp. means higher CFO)