QUESTION 1
Five years ago, Cayman's Crafters, Inc. issued new 25 year convertible bonds with a 4% coupon rate, compounded semi-annually. The bond has a par value of 10,000. The market's required rate of return on similar securities at the time of issuance was 3.8%, compounded semi-annually. The bond indenture indicates that conversion ratio is 175, that is 1 bond can be converted in to 175 shares of Cayman's common stock. Today, the yield to maturity on 20 year bonds is 2.6%, compounded semi-annually and 2.8%, compounded semi-annually on 25 year bonds. The current market price of the stock is $65. You purchased the bond 5 years ago. Decide whether you should convert the bond today or sell it today. Based on your decision, calculate the rate of return you earned while holding the bond over the 5 year period?
QUESTION 2
Cayman's Crafters is also considering issuing new shares of common stock. Their investment banker has advised them that it is a good time to sell and that the market's required rate of return on similar securities is currently 8.5%. Cayman's analysts predict that the growth rate of earnings and dividends for the next four years will be 22% but that after that, they will grow at a constant rate of 3.2% indefinitely. Shareholders received a $8.00 dividend, yesterday.
You are interested in buying the stock, however, you don't have enough money today. You will be receiving a bonus check in 2 years and at that time, you will buy Cayman's common stock. What price will you pay if the market's required rate of return remains constant?