Question

Determining values - convertible bond. Craig's Cake Company has an outstanding issue of 9-year convertible bonds with a $800 par value. These bonds are convertible into 85 shares of common stock. They have a 14% annual coupon interest rate, whereas the interest rate on straight bonds of similar risk is 15%.

a) Calculate the straight bond value of this bond.

b) Calculate the conversion​ (or stock) value of the bond when the market price is ​$88 per share of common stock.

c) What is the minimum market value of the​ bond?

Answer 1

a. The straight value of the bond is computed as shown below:

Coupon payment is computed as follows:

= Par value x coupon rate

= $ 800 x 14%

= $ 112

So, the value of the bond is computed as follows:

= $ 112 / 1.15¹ +  $ 112 / 1.15² +  $ 112 / 1.15³ +  $ 112 / 1.15⁴ +  $ 112 / 1.15⁵ +  $ 112 / 1.15⁶ +  $ 112 / 1.15⁷ +  $ 112 / 1.15⁸ +  $ 112 / 1.15⁹ +  $ 800 / 1.15⁹

= $ 761.83 Approximately

b. The conversion value of the stock is computed as shown below:

= $ 88 x number of common stock

= $ 88 x 85

= $ 7,480

c. The minimum market value is

= $ 761.83