Mills Trucking Inc. has debentures ($1,000 par value) outstanding that are convertible into the company's common stock at a price of $25. The convertibles have a coupon interest rate of 8% and mature 20 years from today. Straight debt of equivalent risk is yielding 10% today. The company's common stock today is selling at $23 a share. Calculate the straight-bond value of the issue.

Question

Quizplus · Accepted Answer

The straight-bond value can be calculated using the present value of the bond's cash flows, which include the annual coupon payments and the principal repayment at maturity. The annual coupon payment is 8% of the $1,000 par value, which equals $80. The present value of these coupon payments, discounted at the 10% market rate for equivalent risk, plus the present value of the $1,000 principal repayment at maturity, gives the straight-bond value. Using the formula for the present value of an annuity and the present value of a lump sum, the calculation is approximately $830.