Question

Mikkleson Mining stock is selling for $40 per share and has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 5.00%. The company is considering issuing a 10-year convertible bond that would be priced at its $1,000 par value. The bonds would have an 8.00% annual coupon, and each bond could be converted into 20 shares of common stock. The required rate of return on an otherwise similar nonconvertible bond is 10.00%. What is the estimated floor price of the convertible at the end of Year 3?

Answer 1

$926.10

Step-by-step explanation:

Determine the estimated floor price of the convertible at the year 3 ending

first step : determine share price at year 3

share price at year 3 = D4 / r - g ---- ( 1 )

where : D4 ( year 4 dividend ) = 2 *(1.05)^3

r ( rate of return ) = 10 %

g ( growth rate ) = 5%

back to equation ( 1 ) = 2 *(1.05)^3 / 10 - 5 = 46.31

Finally ; estimated floor price of the convertible at year 3 ending

= 46.31 * 20 = 926.10