Today you purchase a $1,000 par value convertible bond of Bunkys Burgers. The bond matures in 30 years and has an annual coupon of 12%, payable semiannually. The yield to the maturity on the bond is 10% a year, compounded semiannually. The bond is convertible into Bunkys common stock at a conversion price of $100 a share. You forecast that the earnings and dividends of Bunkys will grow at annual rates of 30% for the next 5 years and then 20% for another 5 years before settling at a 6% growth rate for the indefinite future. Yesterday the firm paid a dividend (D0) of $2.72. Stockholders require a return of 18% on stocks in Bunkys risk class.

{a} You hold the bond for 7 years and then convert it. Assume that all your forecasts hold. What IRR did you earn over the 7 year period?

{b} If you hold the bond for 30 years and convert it the day it matures, what rate of return did you earn if all the forecasts come true? (Assume that you do receive the final coupon payment).