Evaluating Annie Hegg's Proposed Investment In Atilier Industries Bonds. Annie Hegg has been considering investing in the bonds of Atilier Industries. The bonds were issued 5 years ago at their $1,000 par value and have exactly 25 years remaining until they mature. They have an 8.0% coupon interest rate, are convertible into 50 shares of common stock, and can be called any time at $1,080. The bond is rated Aa by Moody's. Atilier Industries, a manufacturer of sporting goods, recently acquired a small athletic-wear company that was in financial distress. As a result of the acquisition, Moody's and other rating agencies are considering a rating change for Atilier bonds. Recent economic data suggest that expected inflation, currently at 5.0% annually, is likely to increase to a 6.0% annual rate.
Annie remains interested in the Atilier bond but is concerned about inflation, a potential rating change, and maturity risk. To get a feel for the potential impact of these factors on the bond value, she decided to apply the valuation techniques she learned in her finance course.
Question 1
If the price of the common stock into which the bond is convertible rises to $30 per share after 5 years and the issuer calls the bonds at $1,080, should Annie let the bond be called away from her or should she convert it into common stock?
Question 2
For each of the following required returns, calculate the bond's value, assuming annual interest. Indicate whether the bond will sell at a discount, at a premium, or at par value.
a) Required return is 6.0%.
b) Required return is 8.0%.
c) Required return is 10.0%.