- 20 Marks
SFM – Nov 2016 – L3 – Q2 – Capital Structure Decisions
Evaluation of convertible loan stock value and growth rate for investment decision-making in Honey Comb Plc
Question
Honey Comb Plc has issued 10% convertible loan stock, redeemable in 10 years on December 31, 2025. The conversion option is available only until December 31, 2017. The issue was sold at ₦920 per ₦1000 of convertible stock. Conversion rate as of January 1, 2016, is 250 equity shares per ₦1000 stock. Non-convertible loan stock with similar risk yields 12%. Current convertible stock price is ₦960, with each equity share priced at ₦3.00 and dividends of ₦0.30 per share.
A holder of this convertible loan stock is contemplating selling or retaining it. Ignore taxation.
Required:
- (a) What is the value of the security as simple unconvertible loan stock? (5 Marks)
- (b) What is the expected minimum annual rate of growth in the equity share price to justify holding the security before the option expires? (12 Marks)
- (c) Recommend a course of action to the security holder with justification. (3 Marks)
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