Solution

To calculate the value of the liability and equity components, we need to first determine the fair value of the loan.

The fair value of the loan can be calculated as the present value of the expected cash flows, discounted at the appropriate market rate of interest. In this case, the appropriate market rate of interest is 12% p.a. because it is commensurate with the credit risk profile of the issuer.

The expected cash flows from the loan are the mandatory interest payments of $96,000 per year (8% of $12 lakhs). Therefore, the fair value of the loan can be calculated as follows:

Fair value of loan = ($96,000 / 0.12) = $8,00,000

Next, we need to allocate the fair value between the liability and equity components based on the specific terms and conditions of the loan.

In this case, the loan is perpetual and has a mandatory interest payment obligation of $96,000 per year. Therefore, the entire fair value of the loan can be allocated to the liability component. The equity component would be zero.

So, the value of the liability component is $8,00,000, and the value of the equity component is zero.

Liability component = $8,00,000

Equity component = $0

Therefore, the financial instrument issued by P Co. Limited to Q Co. Limited would be classified as a financial liability.