The Swift Company is planning to finance an expansion. The principal executives
of the company agree that an industrial company such as theirs should finance
growth by issuing common stock rather than by taking on additional debt.
Because they believe that the current price of Swift’s common stock does not
reflect its true worth, however, they have decided to sell convertible bonds. Each
convertible bond has a face value equal to $1,000 and can be converted into
25 shares of common stock
a. What would be the minimum price of the stock that would make it beneficial for
bondholders to convert their bonds? Ignore the effects of taxes or other costs.
b. What would be the benefits of including a call provision with these bonds?
Answers
I REALLY DON'T KNOW.....
SORRY
Answer:
a) $40
Explanation:
a) Estimate the conversion price:
Given,
Face Value= $1000
Conversion Rate= 25
Conversion Price= Face Value / Conversion Rate
= (1000/25) = $40
b) Convertible bond with a call provision:
A convertible bond would be usually offered at a lower interest rate due to the potential earnings that the investor might gain by converting bond into shares when the price of the shares increases. The inclusion of a call provision would require a higher interest rate, which aims to offset the risk that bond will be called before the maturity. The answer in this case would depend on how the firm forecasts the future price of the share. If the share price is significantly higher than the conversion price of $200, a call provision should be included since the firm might issue new shares at a higher price after bonds are retired.