Evaluating AnnieHegg's Proposed Investment in Atilier Industries Bonds Annie Hegg has been considering investing in the bonds of Atilier Industries. The bonds were issued 5

5 years ago at their $ 1 comma 000

$1,000 par value and have exactly25

25 years remaining until they mature. They have an 8.0 %

8.0% coupon interestrate, are convertible into 50

50 shares of commonstock, and can be called any time at $ 1 comma 080.00

$1,080.00. The bond is rated Aa byMoody's. AtilierIndustries, a manufacturer of sportinggoods, recently acquired a smallathletic-wear company that was in financial distress. As a result of theacquisition, Moody's and other rating agencies are considering a rating change for Atilier bonds. Recent economic data suggest that expectedinflation, currently at 5.0 %

5.0% annually, is likely to increase to a 6.0 %

6.0% annual rate.

Annie remains interested in the Atilier bond but is concerned aboutinflation, a potential ratingchange, and maturity risk. To get a feel for the potential impact of these factors on the bondvalue, she decided to apply the valuation techniques she learned in her finance course.

To Do

a. If the price of the common stock into which the bond is convertible rises to $ 30.00

$30.00 per share after 5

5 years and the issuer calls the bonds at $ 1 comma 080.00

$1,080.00, should Annie let the bond be called away from her or should she convert it into commonstock?

b. For each of the following requiredreturns, calculate thebond's value, assuming annual interest. Indicate whether the bond will sell at adiscount, at apremium, or at par value.

(1) Required return is 6.0 %

6.0%.

(2) Required return is 8.0 %

8.0%.

(3) Required return is 10.0 %

10.0%.

c. Repeat the calculations in part (b), assuming that interest is paid semiannually and that the semiannual required returns areone-half of those shown. Compare and discuss differences between the bond values for each required return calculated here and in part (b) under the annual versus semiannual payment assumptions.

d. If Annie strongly believes that expected inflation will rise by 1.0 %

1.0% during the next fewmonths, what is the most she should pay for thebond, assuming annualinterest?

e. If the Atilier bonds are downrated byMoody's from Aa toA, and if such a rating change will result in an increase in the required return from 8.0 %

8.0% to 8.75 %

8.75%, what impact will this have on the bondvalue, assuming annualinterest?

f. If Annie buys the bond today at its $ 1 comma 000

$1,000 par value and holds it for exactly 3

3 years, at which time the required return is 7.0 %

7.0%, how much of a gain or loss will she experience in the value of the bond(ignoring interest already received and assuming annualinterest)?

g. Rework part (f), assuming that Annie holds the bond for 10

10 years and sells it when the required return is 7.0 %

7.0%. Compare your finding to that in part (f), and comment on thebond's maturity risk.

h. Assume that Annie buys the bond at its current price of $ 983.80

$983.80 and holds it until maturity. What will her current yield and yield to maturity(YTM) be, assuming annualinterest?

i. After evaluating all of the issues raisedabove, what recommendation would you give Annie with regard to her proposed investment in the Atilier Industriesbonds?