A debenture of the Allegro Company (par value $1,000) is convertible into the company's common stock at a price of $50 per share. The convertible bond has a coupon interest rate of 7% and matures in 10 years. Straight debt of equivalent risk and maturity is yielding 8%. The company's common stock is currently selling for $60 per share. Determine the conversion value and straight-bond value of Allegro Company's convertible bonds.
A) $1,200; $1,000
B) $1,000; $933
C) $1,200; $933
D) $1,000; $1,000

Question

Quizplus · Accepted Answer

Conversion value = Par value of bond / Conversion price per share = $1,000 / $50 = 20 shares
Conversion value = 20 shares x $60 per share = $1,200

Straight-bond value = Present value of annual coupon payments + Present value of principal repayment
Coupon payment = Par value of bond x Coupon rate = $1,000 x 7% = $70 per year
Number of periods = 10 years
Discount rate = 8%
PV of coupon payments = $70 x (1 - 1 / (1 + 8%)^10) / 8% = $530.57
PV of principal repayment = $1,000 / (1 + 8%)^10 = $463.19
Straight-bond value = $530.57 + $463.19 = $993.76

Therefore, the correct answer is option C.

A Debenture of the Allegro Company (Par Value $1,000) Is