Quantum, Inc. needs to raise $25 million to construct production facilities for a new model diskette drive. The firm’s straight non-convertible bonds currently yield 14%. Its stock sells for $30 per share; the last dividend was $2; and the expected growth rate is a constant 9%. The firm has decided to raise the $25 million through issuing convertible bonds. The convertibles would have a $1000 par value, carry a coupon of 12%, have a 20-year maturity, and be convertible into 20 shares of stock. The management intends to force conversion when the conversion value exceeds 20% above the bonds’ par value. Quantum has a marginal tax rate of 40%.

a) What is the convertible bond’s straight debt value? What is the implied value of the convertibility feature if the convertible bonds were sold at par?

b) Compute the year in which the bonds are expected to be converted (forced conversion).

c) What is the expected before-tax yield on the convertible bonds to the investors if the bonds are sold at par? Compute the after-tax cost to Quantum if the bonds are sold at par.