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Mikkleson Mining stock is selling for $40 per share and has an expected dividend in the...

Mikkleson Mining stock is selling for $40 per share and has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 5.00%. The company 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%. What is the value of the conversion option at bond issuance?

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Answer #1

Given value of stock is 40

Calculation of straight Value of bond

Required return is 10%

Face value = 1000

Coupon rate is 8% and time is 10 years

Value of bond is

80(PVIFA 10% 10 y) +1000(pvif 10% 10y)

80(6.1446) + 1000(0.3855) = 877

Straight Value is 877

Converstion ratio is 20

Stock price is 40

Value of convertable bond is 20×40 = 800

As straight Value is more than market value of shares will be issued. It will be traded at straight Value so converstion option value is 0

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