Memtech Ltd. needs to raise $15 million to construct production facilities for a new type of USB

Question:

Memtech Ltd. needs to raise $15 million to construct production facilities for a new type of USB memory device. The firm's straight nonconvertible debentures currently yield 8%. Its stock sells for $23 per share, its most recent dividend (00) was $2.00, and the dividend has an expected constant growth rate of 6%. Investment bankers have tentatively proposed that the firm raise the $15 million by issuing convertible debentures. These convertibles would have a $1,000 par value, carry a coupon rate of 7%, have a 20-year maturity, and be convertible into 35 shares of stock. Coupon payments would be made annually. The bonds would be noncallable for 5 years, after which they would be callable at a price of $1,075; this call price would decline by $5 per year in Year 6 and each year thereafter. For simplicity, assume that the bonds may be called or converted only at the end of a year, immediately after the coupon and dividend payments. Assume that management would call eligible bonds if the conversion value exceeded 25% of par value (not 25% of call price).

a. At what year do you expect the bonds will be forced into conversion with a call? What is the bond's value in conversion when it is converted at this time? What is the cash flow to the bondholder when it is converted at this time?

b. What is the expected rate of return (i.e., before-tax component cost) on the proposed convertible issue?

Debentures
Debenture DefinitionDebentures are corporate loan instruments secured against the promise by the issuer to pay interest and principal. The holder of the debenture is promised to be paid a periodic interest and principal at the term. Companies who... Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a... Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their... Par Value
Par value is the face value of a bond. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. The market price of a bond may be above or below par,...

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