5. City Tire has issued 100 convertible bonds with a conversion ratio of 20. Cur

Question

5. City Tire has issued 100 convertible bonds with a conversion ratio of 20. Currently the bonds have not been converted and City Tire has 3,000 shares of common stock outstanding. (a) [5 points] If the convertible bondholders convert their bonds into stock, how many shares of City Tire stock will be outstanding? (b) [5 points] If the stock price is $30, what is the conversion value of the bonds? (c) [5 points] The convertible bonds are approaching maturity. On the maturity date each bondholder who has not converted is entitled to a final payment of $1000. What is the lowest stock price at which a convertible bondholder would find it in his/her interest to convert the bonds before they mature?

Explanation / Answer

If the convertible bondholders convert their bonds into stock, how many shares of City Tire stock will be outstanding?

City Tire Part A Conversion ratio =20 Converted number of common stock = 100 convertible bonds * 20 = 2000 common stock

Current number of common stock outstanding = 3,000

add: Converted common stock = 2,000

Total number of common stock outstanding = 3,000 add 2,000= 5,000

(b) [5 points] If the stock price is $30, what is the conversion value of the bonds?

Part B Converted number of common stock = 100 convertible bonds * 20 = 2000 common stock

Current price of stock = $ 30 per share

Conversion value of bonds = 2000 shares * $ 30 per share = $ 60,000

c) [5 points] The convertible bonds are approaching maturity. On the maturity date each bondholder who has not converted is entitled to a final payment of $1000. What is the lowest stock price at which a convertible bondholder would find it in his/her interest to convert the bonds before they mature?

Part C Final payment for each bondholder = $ 1,000 Conversion ratio =20 Price per share if converted = $ 1,000/20 = $50

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