Anne Hegen

Annie Hegg has been considering investing in the bonds of Atilier Industries. The bonds were issued 5 years ago at their P1000 par value and have exactly 25 years remaining until they mature. They have an 8% coupon interest rate, are convertible into 50 shares of common stock, and can be called any time at P1080. 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 the inflation, currently at 5% annually, is likely to increase to a 6% annual rate. Annie remains interested in the Atilier bond is concerned about inflation, a potential rating change, and maturity risk. In order 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 financial course.

Required:

a. If price of the common stock into which the bond is convertible rises to P30 per share after 5 years and the issuer calls the bonds at P1080, should Annie let the bond be called away from her or should she convert it into common stock?

b. 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.
1) Required return is 6% 2) Required return is 8% 3) Required return is 10%

c. Repeat the calculation in part b, assuming that interest is paid semiannually and that the semiannual required returns are one-half of those shown. Compare and discuss differences between the bond values for each required return calculated here and in part b under the annual versus semiannual payment assumption.

d. If Annie strongly believes that inflation will rise by 1% during the next 6 months, what is the most she should pay for the bond, assuming annual