Standard Olive Company of California has a convertible bond outstanding with a c

Question

Standard Olive Company of California has a convertible bond outstanding with a coupon rate of 5 percent and a maturity date of 10 years. It is rated Aa, and competitive, nonconvertible bonds of the same risk class carry a 12 percent return. The conversion ratio is 15. Currently the common stock is selling for $25 per share on the New York Stock Exchange.

a. What is the conversion price? (Round your answer to 2 decimal places.)
  

b. What is the conversion value? (Round your answer to 2 decimal places.)
  

c. Compute the pure bond value. (Use semiannual analysis.) Use Appendix B and Appendix D as an approximate answer, but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 decimal places.)
  

d. Calculate the crossover point at which the pure bond value equals conversion value. (Do not round intermediate calculations. Round your answer to 2 decimal place

Explanation / Answer

a. Conversion Price = Par Value of the bond/ conversion ratio

Let us suppose that the par value of the bond is $1000

Or, Conversion Price = $1000/15 = $66.67

b. Conversion Value = Current Price of the common stock * Conversion Ratio

Or, Conversion Value = $25*15 = $375

c. Calculation of the pure bond Value;

Coupon Rate = 5%

Face Value of the bond = $1000

Yield to Maturity = 12%

Time to Maturity = 10 years

Or, Price of the Bond = Coupon Interest * pvifa (ytm%, n years) + Face Value* pvif (ytm%, n years)

Or, Price of the bond = $1000*5%*pvifa (12%, 10years) + $1000*pvif (12%, 10yrs)

Or, price of the bond = $50*(5.6502) + 1000* (0.322) = $604.50

Price of the bond is $604.50

d. Cross Over Point at which bond value equals the conversion value = Price of the bond/ conversion ratio = $604.50/15 = $40.30

If the return% rises the value of the bond will fall and if the return% falls the value of the bond will rise. The stock price is currently pegged at $25 so as it rises near the crossover point of $40.30 the bond price will react to it positively.

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