Cheung Zap Inc. just issued five-year convertible bonds at a par value of $1,000
ID: 2617426 • Letter: C
Question
Cheung Zap Inc. just issued five-year convertible bonds at a par value of $1,000. At any time before maturity, investors have the option to exchange their bonds for shares of Cheung's common stock at a conversion price of $56.64. Cheung's convertible bonds pay a 7.08% annual coupon, but if Cheung had issued straight-debt bonds (no conversion), it would have had to pay 11.80% annual interest. Based on the information available, complete the table: Value Conversion ratio of Cheung's bond issue: Pure-debt value of this convertible debt issue: Value of the convertible option: Cheung's common stock currently sells for $36 per share. Would an investor want to convert the bonds now? O Yes O No Suppose analysts expect Cheung to pay a dividend of $4.00 per share at the end of the year and for the dividend to grow at a constant rate of 6% per year. What is the expected conversion value five years from now? O $850.86 O $638.15 O $1,276.29 o $2,728.92Explanation / Answer
(a) Conversion Price = $ 56.64 and Bond Par Value = Bond Market Value = $ 1000
Conversion Ratio = 1000 / 56.64 = 17.65 or 17 shares per bond approximately.
(b) Coupon Rate = 7.08 % and yield = 11.8 %
Annual Coupon = 0.0708 x 1000 = $ 70.8
Therefore, Market Price of Straight Bond = 118 x (1/0.118) x [1-{1/(1.118)^(5)}] + 1000 / (1.118)^(5) = $ 829.01
(c) Value of Straight Bond = $ 829.01 and Value of Convertible Bond = $ 1000
Value of Conversion Option = 1000 - 829.01 = $ 170.99
(d) If the current stock price is $ 36, the investor will not convert because under the conversion clause the investor is paying $ 56.64 per share which is higher than the current stock price.
NOTE: Please raise a separate query for the solution to the last sub-part.
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