Question

Question 2

1. Trump Limited has an outstanding issue of convertible bonds with $1,000 par value. These bonds are convertible into 50 shares of Ali’s common stock. The convertible bonds have a 10% coupon with 10-year maturity. The yield-to-maturity for a straight bond of similar risk is 8%.

i.	Calculate the straight bond value of the convertible bond.
ii.	What is the conversion value of the convertible bond when the
	market price of Trump’s common stock is $30 per share?
iii.	If the market price of common stock were $18 per share, what
	would be the least selling price of the convertible bond?

2. Prince Equipment has to decide whether to obtain $1,000,000 of financing by: (1) selling common stock at its current price of $40 per share or (2) selling convertible bonds. The firm currently has 250,000 shares of common stock outstanding. If it issues convertible bonds, a bond will be sold at $1,000 par value and the convertible price at $45. Prince Equipment expects its earnings available to common stockholders to be $700,000 each year over the next several years.

i.          Calculate the number of shares the firm would need to sell to                          

raise the $1,000,000.

ii.          Find out the diluted earnings per share resulting from the sale of                     

common stock.

3

iii.	Evaluate the number of shares outstanding once all convertible
	bonds have been converted.
iv.	Assess the earnings per share associated with the bond financing
	after conversion.
v.	Which of the financing alternatives would you recommend the
	company adopt? Why?

3. Ryan is the financial manager of Open Corporation. He has been asked to conduct a lease-versus-purchase analysis on a new molding machine. The machine costs $360,000 and will be depreciated by the straight-line method over 5 years with zero residual value.

Alternatively, the company can lease the machine with year-end payments of $95,000 over 5 years from Alpha Finance. The company’s tax rate is 35% and its before-tax cost of borrowing is 10%.

Should the company lease or purchase the machine? Support your

answer with detail computations.                                                                                                 

Answer 1

			Par Value	$1,000
		Pmt	AnnualCoupon payment	$100	(1000*0.1)
		Nper	Number of years	10
		Rate	Yield to maturity	8%
		Fv	Payment at maturity	$1,000
	i	PV1	Straight Bond Value of the convertible Bond	$1,134.20	(Using PV function of excel with Rate=8%, Nper=10, Pmt=-100, Fv=-1000)
			Market price of common tock $30 per share
		Fv	Amount to be received at maturity=	$1,500	(50*30)
	ii	PV2	Conversion value of the Bond	$1,365.80	(Using PV function of excel with Rate=8%, Nper=10, Pmt=-100, Fv=-1500)
			Market price of common tock $18 per share
		Fv	Amount to be received at maturity=	$900	(50*18)
	iii	PV3	Conversion value of the Bond	$1,087.88	(Using PV function of excel with Rate=8%, Nper=10, Pmt=-100, Fv=-1500)
			Least Selling Price	$1,087.88