A firm has an outstanding 15-year convertible bond issue with a $1,000 par value and a stated annual interest rate of 7 percent. The bond is convertible into 50 shares of common stock which has a current market price of $25. A straight bond could have been sold with a 10 percent stated interest rate. The conversion value of the bond is ________.

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The annual interest payment for the convertible bond is $70 (=$1,000 * 7%). The straight bond with a 10% interest rate would have an annual interest payment of $100 (=$1,000 * 10%). The conversion ratio is 50 shares per bond, so each share is worth $20 (=$1,000 ÷ 50). Therefore, the conversion value of the bond is $1,250 (=$25 per share * 50 shares). This is higher than the straight bond's present value, so the bondholders may opt to convert the bond into shares of common stock.

A Firm Has an Outstanding 15-Year Convertible Bond Issue with a $1,000