20-5 Convertible Bond Analysis

Fifteen years ago, Roop Industries sold$500 million of convertible bonds. The bonds had a 20-year maturity, a 6.00% coupon rate, and paid interest annually. They were sold at their $1,000 par value. The conversion price was set at $62.50, and the common stock price was $50 per share. The bonds were subordinated debentures and were given an A rating; straight nonconvertible debentures of the same quality yielded about 8.00%at the time Roop's bonds were issued.

a. Calculate the premium on the bonds-that is, the percentage excess of the conversion price over the stock price at the time of issue.

b. What is Roop's annual before-tax interest savings on the convertible issue versus a straight-debt issue?

c. At the time the bonds were issued, what was the value per bond of the conversion feature?

d. Suppose the price of Roop's common stock fell from $50 on the day the bonds were issued to $40.00 now, 10 years after the issue date (also assume the stock price never exceeded. $62.50 ). Assume interest rates remained constant. What is the current price of the straight-bond portion of the convertible bond? What is the current value if a bondholder converts a bond? Do you think it is likely that the bonds will be converted? Why or why not?