To determine whether it is favorable to convert the convertible bond into shares in 5 years, we need to compare the future cash flows from holding the bond with the future cash flows from converting it into shares.
Future cash flows from holding the bond:
The bond has a par value of €100,000 and a 10% coupon rate. The coupon payment each year would be €10,000 (10% of €100,000).
Therefore, the cash flow from holding the bond for 5 years would be:
€10,000 × 5 = €50,000
Future cash flows from converting into shares:
The conversion price is €5,000 per share, and the current share price is €4,300. This means that for each bond, you can convert €5,000/€4,300 = 1.16 shares.
After 5 years, the dividend per share would be €200, growing at a rate of 6% per year.
The cash flow from converting the bond into shares after 5 years would be:
1.16 shares × (€200 × (1 + 6%)^5) = 1.16 shares × (€200 × 1.338225) = €313.38
Determine the present value of the cash flows:
To make a fair comparison, we need to discount the cash flows to present value using the given required rate of return of 10.93%.
The present value of holding the bond for 5 years:
PV_holding = €50,000 / (1 + 10.93%)^5 = €31,262.46
The present value of converting into shares after 5 years:
PV_converting = €313.38 / (1 + 10.93%)^5 = €199.81
Comparing the present values, we find that PV_holding > PV_converting. This means that the present value of holding the bond for 5 years is greater than the present value of converting into shares. Therefore, as a bondholder, it would be more favorable to hold the bond rather than convert it into shares in 5 years time.