Maggie's Magazines (MM) has straight nonconvertible bond that currently yield 7%. MM's stock sells for $22 per share, has an expected constant growth rate of 7%, and has a dividend yield of 4%. MM plans on issuing convertible bonds that will have a $1,000 par value, a coupon rate of 6%, a 20-year maturity, and a conversion ratio of 32 (i.e., each bond could be convertible into 32 shares of stock). Coupon payments will be made annually. The bonds will be noncallable for 5 years, after which they will be callable at a price of $1,090; this call price would decline by $6 per year in Year 6 and each year thereafter. For simplicity, assume that the bonds may be called or converted only at the end of a year, immediately after the coupon and dividend payments. Management will call the bonds when the bonds’ conversion value exceeds 25% of the bonds’ par value (not their call price). Inputs: Straight bond yield7% Current stock price$22.00 Expected growth rate in stock price7% Dividend yield4% Par value (and issue price) of convertible bond$1,000.00 Coupon rate on convertible bond6.00% Maturity of convertible bond (years)20 Conversion ratio32 Call protection period (years)5 Call price when call protection ends$1,090.00 Call price decline per year after protection period$6.00 Policy for call: Call when conversion value exceeds this percent over bond's par value.25% a. For each year, calculate: (1) the anticipated stock price; (2) the anticipated conversion value; (3) the anticipated straight-bond price; and (4) the cash flow to the investor assuming conversion occurs. At what year do you expect the bonds will be forced into conversion with a call? What is the bond’s value in conversion when it is converted at this time? What is the cash flow to the bondholder when it is converted at this time (Hint: the cash flow includes the conversion value and the coupon payment, because the conversion is immediately after the coupon is paid.)

Given: The data's are given as,

Answered: a conversion ratio of 32 (i.e., each…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

See similar textbooks

Related questions

Concept explainers

Question

Maggie's Magazines (MM) has straight nonconvertible bond that currently yield 7%. MM's stock sells for $22 per share, has an expected constant growth rate of 7%, and has a dividend yield of 4%. MM plans on issuing convertible bonds that will have a $1,000 par value, a coupon rate of 6%, a 20-year maturity, and a conversion ratio of 32 (i.e., each bond could be convertible into 32 shares of stock). Coupon payments will be made annually. The bonds will be noncallable for 5 years, after which they will be callable at a price of $1,090; this call price would decline by $6 per year in Year 6 and each year thereafter. For simplicity, assume that the bonds may be called or converted only at the end of a year, immediately after the coupon and dividend payments. Management will call the bonds when the bonds’ conversion value exceeds 25% of the bonds’ par value (not their call price).









Inputs:
Straight bond yield	7%
Current stock price	$22.00
Expected growth rate in stock price	7%
Dividend yield	4%
Par value (and issue price) of convertible bond	$1,000.00
Coupon rate on convertible bond	6.00%
Maturity of convertible bond (years)	20
Conversion ratio	32
Call protection period (years)	5
Call price when call protection ends	$1,090.00
Call price decline per year after protection period	$6.00
Policy for call: Call when conversion value exceeds this percent over bond's par value.	25%

a. For each year, calculate: (1) the anticipated stock price; (2) the anticipated conversion value; (3) the anticipated straight-bond price; and (4) the cash flow to the investor assuming conversion occurs. At what year do you expect the bonds will be forced into conversion with a call? What is the bond’s value in conversion when it is converted at this time? What is the cash flow to the bondholder when it is converted at this time (Hint: the cash flow includes the conversion value and the coupon payment, because the conversion is immediately after the coupon is paid.)

Expert Solution

Trending now

This is a popular solution!

Step by step

Solved in 2 steps with 3 images

SEE SOLUTION Check out a sample Q&A here

Knowledge Booster

Learn more about

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, accounting and related others by exploring similar questions and additional content below.