Convertible Debt

12 Months Ended

Dec. 31, 2011

As described in note 5, in August 2010, the Company issued a $120,695 convertible debenture in settlement of a debt that was owed to a former related party and then assigned to a third party in July 2010.

The convertible debenture matures two years from the date of issuance and bears interest at a 20% rate per annum, is unsecured and is convertible into the Company’s common stock at any time at the holder’s option, into common stock at the conversion rate of 25% of the average of the five lowest trading days 30 days prior to notice of conversion.

The Company analyzed the conversion option for derivative accounting consideration under ASC 815-15 “Derivatives and Hedging” and determined that the instrument should be classified as a liability due to their being no explicit limit to the number of shares to be delivered upon settlement of the above conversion options. The accounting treatment of derivative financial instruments requires that the Company record fair value of the derivatives as of the inception date of the convertible promissory note and to fair value the instrument as of each subsequent balance sheet date or termination of the instrument with the change in fair value recorded to earnings. At inception of the convertible promissory note, the Company determined the embedded derivative had a fair value of $857,254.

The Company determined the fair value of the embedded debt derivative as of December 31, 2010 to be $290,761.

The Company revalued the embedded derivative as of December 31, 2011. The fair value of the embedded derivative was determined using the Black Scholes Option Pricing Model based on the following assumptions:

Dividend yield:	0	%
Volatility	283.68	%
Risk free rate	0.06	%

The Company determined the fair value of the embedded debt derivative as of December 31, 2011 to be $959,221. The increase was charged to current period operations as a loss on derivative.

During the twelve months ended December 31, 2011, the Company amortized debt discount of $14,193 to current period operations as interest expense.

Summary of this convertible debenture at December 31, 2011 is as follows:

Convertible debenture	$	120,695
Less unamortized debt discount		(100,207	)
Net		20,488

Current portion:	$	20,488
Long term portion:		-

The following table summarizes the derivative liabilities included in the balance sheet:

Balance at December 31, 2010	$	290,761
ASC 815-15 additions (convertible debt)		-
Change in fair value		668,460
Balance as of December 31, 2011		959,221

The following table summarizes the derivative gain or (loss) recorded as a result of the derivative liabilities above:

Change in fair value			(668,460	)
Balance as of December 31, 2011			( 668,460	)

MAJIC WHEELS CORP 10-K