Q9BP Sherwood Forest Products has a c... [FREE SOLUTION]

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Foundations Of Financial Management

Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen

Business Studies

16th Edition 路 768 pages

ISBN: 9781259277160

Chapter 5: Q9BP (page 624)

Sherwood Forest Products has a convertible bond quoted on the NYSE bond market at 90. (Bond quotes represent percentage of par value. Thus 70 represents $700, 80 represents $800, and so on.) It matures in 10 years and carries a coupon rate of 5陆 percent. The conversion ratio is 25, and the common stock is currently selling for $33 per share on the NYSE.
Compute the conversion premium.
At what price does the common stock need to sell for the conversion value to be equal to the current bond price?

Short Answer

Expert verified

The conversion premium is $75
The stock price is $36

Step by step solution

Meaning of Common Stock

The standard ownership stake in a firm is called common stock. In other words, it's a strategy of apportioning corporate ownership; as a result, each share of common stock corresponds to a certain extent of an organization.

(a) Computing conversion premium

Given,

Convertible bond quoted on the NYSE bond market at 90 represented as $900

Calculation of Conversion value

$\begin{array}{rcl} C o n v e r s i o n v a l u e & = & C o m m o n s t o c k p r i c e 脳 C o n v e r s i o n 鈥� r a t i o \\ = & 33 脳 25 \\ = & $ 825 \end{array}$

Calculation of Conversion premium

$\begin{array}{rcl} C o n v e r s i o n p r e m i u m & = & B o n d p r i c e - C o n v e r s i o n v a l u e \\ = & $ 900 - $ 825 \\ = & $ 75 \end{array}$

(b) Explaining the price the common stock needs to sell for the conversion value to be equal to the current bond price

Calculation of price of the bond

$\begin{array}{rcl} S t o c k p r i c e & = & \frac{B o n d p r i c e}{C o n v e r s i o n r a t i o} \\ = & \frac{$ 900}{25} \\ = & $ 36 \end{array}$

The stock price is $36; it must sell to be equal to the bond price. At this price, conversion price and bond price are equal.

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Bailey corporation
Income statement
For the year 20X1
Sales (all on credit)	\(42,680,000
Cost of goods sold	\)32,240,000
Gross profit	\(10,440,000
Selling and administrative expenses	\)4,558,000
Operating profit	\(5,882,000
Interest expense	\)600,000
Net income before taxes	\(5,282,000
Taxes	\)2,120,000
Net income	\(3,162,000

Bailey corporation
Balance sheet
As of December 31, 20X1
Assets
Current assets:
Cash	\)250,000
Marketable securities	\(130,000
Accounts receivables	\)6,000,000
Inventory	\(8,300,000
Total current assets	\)14,680,000
Net plant and equipment	\(13,970,000
Total assets	\)28,650,000
Liabilities and stockholders鈥� equity
Current liabilities:
Accounts payable	\(3,800,000
Notes payable	\)3,550,000
Total current liabilities	\(7,350,000
Long-term liabilities	\)5,620,000
Total liabilities	\(12,970,000
Stockholder鈥檚 equity:
Common stock (1,800,000 shares at \)1 par)	\(1,800,000
Capital in excess of par	\)6,300,000
Retained earnings	\(7,580,000
Total stockholder鈥檚 equity	\)15,680,000
Total liabilities and stockholder鈥檚 equity	$28,650,000

Assets
	Book value	Liquidation value
Accounts receivables	\(1,400,000	\)1,200,000
Inventory	\(1,800,000	\)900,000
Machinery and equipment	\(1,100,000	\)600,000
Building and plant	\(4,200,000	\)2,500,000
Total assets	\(8,500,000	\)5,200,000

Liabilities and stockholder鈥檚 claims
Liabilities
Accounts payable	\(2,800,000
First lien, secured by machinery and equipment	\)900,000
Senior unsecured debt	\(2,200,000
Subordinated debenture	\)1,700,000
Total liabilities	\(7,600,000
Stockholder鈥檚 claims
Preferred stock	\)250,000
Common stock	\(650,000
Total stockholder鈥檚 claims	\)900,000
Total liabilities and stockholder鈥檚 claims	\(8,500,000

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Short Answer

Step by step solution

Meaning of Common Stock

(a) Computing conversion premium

(b) Explaining the price the common stock needs to sell for the conversion value to be equal to the current bond price

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