?A convertible bond has the following features: Coupon 6.5% Maturity date 10 years Exercise price $20 Principal $1,000 Call price $1,065 ? Convertible preferred stock Annual dividend $2.25 Convertible into 2.5 shares of common stock Callable at $25 a share ? Currently the common stock is selling for $13; the yield on non?convertible bonds is 10%, and the yield on comparable preferred stocks is 14%. What is the value of the above securities in terms of the common stock? What would be the value of each security if it lacked the conversion feature?
What will be an ideal response?
Value of the convertible bond as stock: First, determine the number of shares into which the bond may be converted: $1,000/$20 = 50 shares.? Next, multiply the number of shares by the price per share: 50 x $13 = $650.??Value of the convertible bond as debt: $65(6.145) + $1,000(0.386) = $785.43?(6.145 and 0.386 are respectively the interest factors for the present value of an annuity and the present value of a dollar at 10 percent for ten years. If a financial calculator is used, enter PMT = 65, FV = 1000, I = 10, N = 10, and solve for PV. In this example, PV = -784.94.)?Since the bond's value as debt exceeds its value as stock, the bond will sell for at least $785.43, its value as debt. (The bond will probably sell for more than $785.43, as it will command a premium over the bond's value as debt.)????Value of the convertible preferred stock as common stock: 2.5 shares x $13 = $32.50?Value of the convertible preferred stock as non?convertible preferred stock: $2.25/.14 = $16.07?Since the conversion value of the stock exceeds its value as non?convertible preferred stock, the convertible preferred stock will sell for at least $32.50, its value as common stock.bond, they would suffer a loss as they would receive only the call price ($1,050).
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