Finance-7862002.xls Download Attachment

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Question:
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Question:
Fifteen years ago, roop industries sold $400 million of convertible bonds. the bonds had a 40-year
maturity, a 5.75% coupon rate, and paid interest annually. they were sold at their $1,000 par value, the
conversion price was set at $62.75, and the common stock price was $55 per share. the bonds were
subordinated debentures and were given an A rating; straight nonconvertible debentures of the same
quality yielded about 8.75% at the time roop's bonds were issued.
a.) calculate the premium on the bonds-- that is, the percentage excess of the conversion price over the
stock price at the time of issue.
Solution: Computation of the Premium on the Bonds
The premium of the conversion price over the stock price was 14.1 percent:
(62.75 / 55) 1 0.141 = 14.1%
b.) what is roop's annual before-tax interest savings on the convertible issue versus a straight-debt
issue?
Solution: The before-tax interest savings is calculated as follows:
$400,000,000(0.0875 - 0.0575) = $12 million per year.
Note:
The after-tax interest savings would be more relevant to the firm and would be calculated as
$12,000,000 (1 - T).
c.) at the time the bonds were issued, what was the value per bond of the conversion feature?
Solution: Computation of the value per bond of the conversion feature
Par Value
$1,000.00
Coupon Amount
$57.50
Yield to Maturity
8.75%
No of Periods
40
Bond Value

$669.11

Notice that this implies that the value of the conversion
Feature at the time of issue was

$330.89

d. Suppose the price of Roops common stock fell from $55 on the day the bonds were issued to
$32.75 now, 15 years after the issue date (also assume the stock price never exceeded $62.75).
Assume interest rates remained constant. What is the current price of the straight-bond portion of
the convertible bond? What is the current value if a bondholder converts a bond? Do you think it is
likely that the bonds will be converted?
Solution: Computation of the value per bond
If interest rates had not changed, then the value of the straight bond 15 Years
Par Value
$1,000.00
Coupon Amount
$57.50
Yield to Maturity
8.75%
No of Periods
25
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