Atlas Anglers Inc.is considering issuing a 15-year convertible bond that will be priced at its $1,000 par value.The bonds have a 6.5% annual coupon rate,and each bond can be converted into 20 shares of common stock.The stock currently sells at $30 a share,has an expected dividend in the coming year of $3,and has an expected constant growth rate of 5.5%.What is the estimated floor price of the convertible at the end of Year 3 if the required rate of return on a similar straight-debt issue is 9.5%?

Question

Quizplus · Accepted Answer

The floor price of a convertible bond is the higher of its straight-debt value and its conversion value. To find the straight-debt value at the end of Year 3, calculate the present value of the remaining cash flows (coupon payments and principal) discounted at the required rate of return for straight debt (9.5%). The conversion value is the value of the shares the bond can be converted into, which is 20 shares times the expected stock price at the end of Year 3. The straight-debt value is lower than the conversion value, so the floor price is the straight-debt value, which is $790.48.