The LeMonde Corporation has debentures outstanding (par value = $1,000) that are convertible into the company’s common stock at a price of $25 per share. The convertibles have a coupon interest rate of 6 percent and mature 20 years from now. In addition, the convertible debenture is callable at 107 percent of par value. The company has a marginal tax rate of 40 percent.
a. Calculate the conversion value if LeMonde’s common stock is selling at $25 a share.
b. Calculate the bond value, assuming that straight debt of equivalent risk and maturity is yielding 9 percent.
c. Using the answers from parts a and b, what is a realistic estimate of the market value of the convertible debentures?
d. What is the conversion value if the company’s common stock price increases to $35 a share?
e. Given the situation presented in part d, what is a realistic estimate of the market value of the convertible debenture?
f. What is the minimum common stock price that will allow LeMonde management to use the call feature of the debentures to effectively force conversion?
g. Suppose that increased expectations concerning inflation cause the yield on straight debt of equivalent risk and maturity to reach 10 percent. How will this affect the bond value of the convertible?