Fifteen years ago, Roop Industries sold $ 400 million of convertible bonds. The

Question

Fifteen years ago, Roop Industries sold $ 400 million of convertible bonds. The bonds had a 40-year maturity, a 5.75% coupon rate, and paid interest annually. They were sold at their $ 1000 par value. The conversion price was set at $ 62.75, and the common stock price was $55 per share.The bonds were subordinated debentures and were given an A rating; straight nonconvertible debentures of the same quality yielded about 8.75 At the time Roop's bonds were issued.

B) what is Roop's annual before-tax interest savings on the convertible issue versus a straight-debt issue?

Explanation / Answer

Sorry I posted the answer for part A again.. here is the correct answer.

Before tax savings  = the difference in payments made between convertible and vanilla bond.

convertible bond pays: 5.75% yearly * 400,000,000 = $23,000,000

If he had to raise $400,000,000 with vanilla bonds he would have to offer 8.75% interest since this is what is offered in the market.

8.75% * 400,000,000 = 35,000,000

Savings = 35,000,000 - 23,000,000 = $12,000,000

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