Valdes Enterprises is considering issuing a 10-year convertible bond that would
ID: 2653324 • Letter: V
Question
Valdes Enterprises is considering issuing a 10-year convertible bond that would be priced at its $1,000 par value. The bonds would have an 8.00% annual coupon, and each bond could be converted into 20 shares of common stock. The required rate of return on an otherwise similar nonconvertible bond is 10.00%. The stock currently sells for $40.00 a share, has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 5.00%. What is the estimated floor price of the convertible at the end of Year 4?
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Explanation / Answer
The floor price would be the higher of straight bond price or the conversion value.
Straight bond price = pv(rate,nper,pmt,fv)
rate =10%
nper (no of year left to maturity) = 10-4 = 6 year
pmt = 1000*8% = 80
fv =1000
Straight bond price = pv(10%,6,80,1000)
Straight bond price = $ 912.89
Conversion value. = Share Price at year 4 * No of share issued per bond
Share Price at year 4 = 40*(1+5%)^4
Share Price at year 4 = $ 48.62025
No of share issued per bond = 20
Conversion value. = 48.62025*20
Conversion value. = $ 972.41
Therefore
Answer
Estimated floor price of the convertible at the end of Year 4 = $ 972.41
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