Suppose a company simultaneously issues $50 million of convertible bonds with a coupon rate of10% and $50 million of straight bonds with a coupon rate of 14%. Both bonds have the same maturity. Does the convertible issue’s lower coupon rate suggest that it is less risky than the straight bond? Is the cost of capital lower on the convertible than on the straight bond? Explain. If the project's cost of capital is 12%, should the machine be purchased?

Suppose a company simultaneously issues $50 million of convertible bonds with a coupon rate of10% and $50 million of straight bonds with a coupon rate of 14%. Both bonds have the same maturity. Does the convertible issue’s lower coupon rate suggest that it is less risky than the straight bond? Is the cost of capital lower on the convertible than on the straight bond? Explain. If the project's cost of capital is 12%, should the machine be purchased?

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter20: Hybrid Financing: Preferred Stock, Warrants, And Convertibles

Section: Chapter Questions

Problem 7Q

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Similar questions

Suppose a company simultaneously issues $50 million of convertiblebonds with a coupon rate of 10% and $50 million of straight bonds with acoupon rate of 14%. Both bonds have the same maturity. Does the convertible issue’s lower coupon rate suggest that it is less risky than the straightbond? Is the cost of capital lower on the convertible than on the straightbond? Explain.
Suppose a company simultaneously issues $50 million of convertible bonds with a couponrate of 9% and $50 million of nonconvertible bonds with a coupon rate of 12%. Bothbonds have the same maturity. Because the convertible issue has the lower coupon rate, isit less risky than the nonconvertible bond? Would you regard the cost of capital as beinglower on the convertible than on the nonconvertible bond? Explain. (Hint: Althoughit might appear at first glance that the convertible’s cost of capital is lower, this is notnecessarily the case, because the interest rate on the convertible understates its true cost.Think about this.)
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