Florida Enterprises is considering issuing a 10-year convertible bond that will be priced at its $1000 par value. The bonds have an 8% annual coupon, and each bond can be converted into 20 shares of common stock. The stock currently sells at $40 a share, has an expected dividend in the coming year of $5, and has an expected constant growth rate of 5%. Similar straight-debt issues yield 10%. The company will force conversion on the bonds as soon as (year-end) the conversion value exceeds the par value on the bonds. The firm is in the 40% marginal tax rate.

a) Compute the price of the straight bond component and the conversion value in Year 3.

b) When will conversion take place?

c) Compute the yield to the investors and the cost to the firm from the convertible bonds.