CHAPTER 24
S&S AIR’S CONVERTIBLE BOND
1. We can use the PE ratio to calculate the current stock price. Doing so, we get:
PE = Price / EPS
This means the conversion premium of the bond is:
Chris is suggesting a conversion price of $25 because it means the stock price will have to increase
before the bondholders can benefit from the conversion, in this case 25 percent. Even though the
The conversion value of the bond is given as $800. The intrinsic value of the bond is:
So, the floor value of the bond is $800. This means that if the company offered bonds with the same
The conversion ratio the bond is:
So, each bond can be converted to 32 shares of stock.
2. Todd’s argument is wrong because it ignores the fact that if the company does well, bondholders will
3. Mark’s argument is incorrect because the company is issuing debt with a lower coupon rate than they
4. Reconciling the two arguments requires that we remember our central goal: to increase the wealth of
In contrast, if a company does poorly, issuing convertible bonds will turn out to be better than
Both of the arguments have a grain of truth; we just need to combine them. Ultimately, which option
is better for the company will only be known in the future and will depend on the performance of the
company. The table below illustrates this point.
If the company does poorly If the company prospers
Low stock price and no
conversion
High stock price and
conversion
Convertible bonds
Cheap financing because
Expensive financing because
Convertible bonds
Expensive financing because
Cheap financing because firm
5. The call provision allows the company to redeem the bonds at the company’s discretion. If the
company’s stock appears to be poised to rise, the company can call the outstanding bonds. It could