Question

Assume the following convertible bond data: We have a 20-year, 10.5% annual coupon, callable convertible bond with 5 years of call protection and $1,100 call price, selling at its $1,000 par value. A straight debt issue would require a 12% coupon. Bond will be called at the issue date anniversary if the conversion value is greater than $1,200. Firm’s last dividends paid was $1.48, and its constant growth rate is 8% per year. Stock price is now $20. The bond can be converted into 40 shares. Firm’s tax rate is 40%. Produce a timeline assuming that the convertible will be converted at year 6, and show all relevant cash flows of the firm and explain how one can compute the convertibles expected cost of capital to the firm!(you do not need to compute it, just show the cash flows and explain how one can compute it.) What is the requirement for the cost of convertible to be consistent with the cost of debt and cost of equity?

Answer 1