Question : 22.Conversion value and changing pure bond value (LO19-3) Tulsa Drilling : 1553920
22.Conversion value and changing pure bond value (LO19-3) Tulsa Drilling Company has $1.3 million in 12 percent convertible bonds outstanding. Each bond has a $1,000 par value. The conversion ratio is 40, the stock price is $36, and the bonds mature in 10 years. The bonds are currently selling at a conversion premium of $60 over the conversion value.
a.Today, one year later, the price of Tulsa Drilling Company common stock has risen to $46. What would your rate of return be if you had purchased the convertible bond one year ago and sold it today? Assume that on the date of sale, the conversion premium has shrunk from $60 to $10. (Hint: Don’t forget to include the interest payment for the first year)
b.Assume the yield on similar nonconvertible bonds has fallen to 8 percent at the time of sale. What would the pure bond value be at that point? (Use semiannual analysis.) Would the pure bond value have a significant effect on valuation then?