Your company needs $100 Million for expansion and decides to issue a 5-year conv

Question

Your company needs $100 Million for expansion and decides to issue a 5-year convertible bond. The stock price currently is $41.67 and your banker recommends a 20% conversion premium. The total option value of the convertible will be $92.22 per $1,000 face amount of bond. The company's current cost of 5-year debt is 3% assuming semi-annual interest payments.

What should be the annual coupon of the convertible bond assuming you want the bond to trade at par? The coupon will be paid semi-annually.

How many shares will each $1,000 bond convert?

What is the return for an investor if the stock price in 5 years is 60?

Explanation / Answer

Now to get 100 million, the company would have to issue debt worth 100/92.2*100 = 108.45 Million.

Now the current cost of debt is 3% so 3% * 108.45 = 3.25 million, now if company want bond to trade at par, then the annual coupon rate would be 3.25/100 = 3.25%.

1000 dollar means 1000/41.67 = approx 24 shares but as the conversion premium is 20% then it would be 1200/41.67 = approx 29 Share.

Now equivalen share price is 1000/28.79 = 34.73 so rate of return would be 11.6% annually

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