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# Convertible Bonds and Calculating Flotation Costs

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Ch 18:
18. Dividends and Firm Value The net income of Novis Corporation is \$32,000. The company has 10,000 outstanding shares and a 100 percent payout policy. The expected value of the firm one year from now is \$1,545,600. The appropriate discount rate for Novis is 12 percent, and the dividend tax rate is zero.
a. What is the current value of the firm assuming the current dividend has not yet been paid?
b. What is the ex-dividend price of Novis's stock if the board follows its current policy?

Ch 19:
7.Calculating Flotation Costs The Green Hills Co. has just gone public. Under a firm commitment agreement, Green Hills received \$19.75 for each of the 5 million shares sold. The initial offering price was \$21 per share, and the stock rose to \$26 per share in the first few minutes of trading. Green Hills paid \$800,000 in direct legal and other costs and \$250,000 in indirect costs. What was the flotation cost as a percentage of funds raised?
Ch 20:
3. Bond Refunding KIC, Inc., plans to issue \$5 million of bonds with a coupon rate of 12 percent and 30 years to maturity. The current market interest rates on these bonds is 11 percent. In one year, the interest rate on the bonds will be either 14 percent or 7 percent with equal probability. Assume investors are risk-neutral.
a. If the bonds are noncallable, what is the price of the bonds today?
b. If the bonds are callable one year from today at \$1,450, will their price be greater than or less than the price you computed in (a)? Why?
Ch 22:
10. Black-Scholes What are the prices of a call option and a put option with the following characteristics?
Stock price = \$38
Exercise price = \$35
Risk-free rate = 6% per year, compounded continuously
Maturity = 3 months
Standard deviation = 54% per year
Ch 24:
Convertible Bonds Hannon Home Products, Inc., recently issued \$430,000 worth of 8 percent convertible debentures. Each convertible bond has a face value of \$1,000. Each convertible bond can be converted into 24.25 shares of common stock anytime before maturity. The stock price is \$31.25, and the market value of each bond is \$1,180.
a. What is the conversion ratio?
b. What is the conversion price?
c. What is the conversion premium?
d. What is the conversion value?

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#### Solution Summary

The solution explains some questions relating to convertible bonds, flotation costs and option prices

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## The question looks at accepting projects, profitability of a planned project, cost of capital, and convertible bonds.

1. The ABC Co. has no debt in its capital structure, a beta of 0.8, and raises all funds through sale of common stock. The current market rate for similar stock is 14% and the risk-free rate is 6%. The firm is considering a project with a return of 12.9%. Should it accept the project, and if so why (Show all work).

2. You have determined the profitability of a planned project by finding the present value of all the cash flow from that project. Which of the following would cause the project to look less appealing, that is, have a lower present value?

a.The discount rate decrease.
b. The Cash flows are extended over a longer period of time.
c. The discount rate increase.
d. B and C are both correct,
e. A and B are both correct.

3. Brooks Window Shielde, Inc. is trying to calculate its cost of capital for use in a capital budgeting decision. Ms. Glass, the vice president of finance, has given you the following information and has asked you to compute weighted average cost of capital.

The company currently has outstanding a bond with an 11.2 percent coupon rate and another bond with a 7.5 percent rate. The firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 12.4 percent.

The common stock has a price of \$54 and an expected dividend (D1) of \$2.70 per share. The firm's historical growth rate of earnings and dividends per share has been 14.5 percent, but security analysts on Wall Street expect this growth to slow to 12 percent in future years.

The preferred stock is selling at \$50 per share and carries a dividend of \$4.75 per share. The corporate tax rate is 35 percent. The flotation cost is 2.8 percent of the selling price for preferred stock. The optimum capital structure for the firm seems to be 35 percent debt, 10 percent preferred stock, and 55 percent common equity in the form of retained earnings.

Compute the cost of capital for the individual components in the capital structure, and then calculate the weighted average cost of capital.

4) DNA Labs, Inc. has a \$1,000 convertible bond outstanding that can be converted into 40 shares of common stock. The common stock is currently selling for \$26.75 a share and the convertible bond is selling for \$1,118.50.

a.What is the conversion value of the bond?
b.What is the conversion premium?
c.What is the conversion price?

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