Rexon Company has an outstanding issue of convertible bonds with a Rs1,000 par value. These are convertible into 50 shares of common stock. They have a 10 per cent coupon and a 10-year maturity. The interest rate on a straight bond of similar risk is 8%.
Present value interest factor of an annuity at 8% for 10 years =6.710
Present value interest factor at 8% for 10 years =0.463
Required:
(i) Calculate the straight bond value of the bond. (2 marks)
(ii) Calculate the conversion value of the bond when the market price of the stock is Rs30/share. (2 marks)
(iii) What is the least you would expect the bond to sell for at a market price of common stock of Rs18/share? (1 mark)
(b) Rexon Company must decide whether to obtain Rs1,000,000 of financing by selling common stock at its current price of Rs40 per share or selling convertible bonds.
The firm currently has 250,000 shares of common stock outstanding.
Convertible bonds can be sold for their Rs1,000 par value and would be convertible at Rs45.
The firm expects its earnings available to common stockholders to be Rs700,000 each year over the next several years.
Required:
(i) Calculate the number of shares the firm would need to sell to raise the Rs1, 000,000. (1 mark)
(ii) Calculate the earnings per share resulting from the sale of common stock.
(2 marks)
(iii) Calculate the number of shares outstanding once all bonds have been converted. (3 marks)
(iv) Calculate the earnings per share associated with the bond financing after conversion. (2 marks)
(v) Which of the financing alternatives would you recommend? Why? (2 marks)
(c) Rexon Company is preparing an investment strategy and has solicited your advice on the risks the company may face.
You are required to advise the company on the sources of business risks.
(10 marks)
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