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ACCA Strategic Professional · Advanced Financial Management · Financing acquisitions and mergers

Beta plc has a convertible bond with a nominal value of $100, 5% annual coupon, and 3 years to maturity. Redemption at par is the alternative to conversion, and the investor's required return on similar straight debt is 8%. Using discount factors at 8% of 0.926, 0.857 and 0.794 for years 1 to 3 (annuity factor 2.577), what is the straight debt (floor) value per bond, to the nearest $0.10?

The floor value is about $92.30. It is the present value of the $5 coupons for three years plus the $100 redemption, discounted at the 8% return required on straight debt. The investor would not pay less than this, because the bond is worth at least its debt value.

  1. A$92.30Correct
  2. B$95.00
  3. C$100.00
  4. D$107.70

Explanation

Interest of $5 x 2.577 = 12.885. Redemption $100 x 0.794 = 79.40. Total = $92.285, about $92.30. Discounting at the 5% coupon rate would give $100, which is wrong because the market rate for straight debt is 8%. $107.70 reverses the sign of the discount.

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