Malta ltd plans to issue 1000 bonds that have a face value of $100 and 8 years t

Question

Malta ltd plans to issue 1000 bonds that have a face value of $100 and 8 years to maturity. the bonds pay a common rate of 8%, paid evry six months and offer the same yield as that of similar risk companies, i.e 2% higher than the government bond rate 5.5%. the potential investors are offered the option to convert each bond held into Malta's ordinary share and expected to pay a dividend of $1.50 per share in the next year. these dividends are expected to grow at 7.5% every year. Assume you are a potential investor and shares in companies with similar risks to malta Ltd are currently tradining at nominal discount rate of 10% per annum. Calculate the value of the bond and the share. Discuss whether you should accept the option to convert Malta Bonds into ordinary shares.

Explanation / Answer

value of the bond can be found by using pv formulae in excel

=pv(rate,nper,pmt,fv,type)

rate=7.5%/2(since semi annual coupon payment and 2% higher than 5.5% )

nper=8*2=16

pmt=8%/2*10=$4

fv=100

type=0

=PV(7.5%/2,16,40,100,0)=$102.967

For 1000 bonds it is 102.967*1000=$102,967

SInce 1000 bonds can be converted into 1000 shares the value of it is

=Dividend present*(1+g)/(k-g)

dividend for 1st year=1.5 g=7.5% k=10%

=1.5/(10%-7.5%)

=60

for 1000 shares it is 60*1000=$60,000

It is better to use it as bonds itself as present value is higher than stocks

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