Question

1. Brown Co. issued $1,000 par value bonds with a 4% coupon rate, convertible into 20 share of Brown common stock. If the market price of the bond is $1,080 and the stock is now at $45 per share and pays a $0.50 per share annual dividend. What is this bond’s payback period?

   		10 years
   		8 years
   		4 years
   		6 years

Answer 1

Bond's payback period = Conversion premium per share / Favourable income differential income per share

i) Conversion premium per share = Market conversion price per share - Market price per share

Conversion premium per share = (Bond price / Conversion ratio) - Market price per share

Conversion premium per share = ($1,080 / 20 share) - $45

Conversion premium per share = $9

ii) Favourable income differential per share = Coupon payment per share - Dividend per share

Favourable income differential per share = (($1,0000 * 4%)/20) - $0.50 per share

Favourable income differential per share = $2 - $0.50

Favourable income differential per share = $1.50

Now put the values into formula :

Bond's payback period = $9 / $1.50 per share

Bond's payback period = 6 years

Answer : 6 years