Convertible Calculations Alicia, Inc., has a $1,000 face value convertible bond issue that is currently selling in the market for $950. Each bond is exchangeable at any time for 25 shares of the company's stock. The convertible bond has a 7 percent coupon, payable semiannually. Similar nonconvertible bonds are priced to yield 9 percent. The bond matures in 10 years. Stock in Alicia sells for $37 per share.

a. What are the conversion ratio, conversion price, and conversion premium?

b. What is the straight bond value? The conversion value?

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

V. Risk and Return

14. Options and Corporate Finance

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CHAPTER 14 Options and Corporate Finance c. In part (b), what would the stock price have to be for the conversion value and the straight bond value to be equal?

d. What is the option value of the bond?

20. Pricing Convertibles You have been hired to value a new 25-year callable, convertible bond. The bond has a 6.20 percent coupon, payable annually. The conversion price is $140, and the stock currently sells for $41.12. The stock price is expected to grow at 12 percent per year. The bond is callable at $1,200, but, based on prior experience, it won't be called unless the conversion value is $1,300. The required return on this bond is 10 percent. What value would you assign?

21. Abandonment Decisions For some projects, it may be advantageous to terminate the project early. For example, if a project is losing money, you might be able to reduce your losses by scrapping out the assets and terminating the project, rather than continuing to lose money all the way through to the project's completion. Consider the following project of Hand Clapper, Inc. The company is considering a four-year project to manufacture clap-command garage door openers. This project requires an initial investment of $8 million that will be depreciated straight-line to zero over the project's life. An initial investment in net working capital of $2 million is required to support spare parts inventory; this cost is fully recoverable whenever the project ends. The company believes it can generate $7 million in pretax revenues with $3 million in total pretax operating costs. The tax rate is 38 percent and the discount rate is 16 percent. The market value of the equipment over the life of the project is as follows:


Market Value (millions)

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