Date: Wednesday, April 11, 2007
Case: Flowers Industries, Inc. - Abridged (UVA-F-0812)
Read: BMA, Chapter 25, pages 680-686.
Network File: Spotrates.xls
Assignment:
1. Using option pricing theory as a basis for your calculations, what is the value of the convertible subordinated debenture? [The standard practice is to view a convertible as having two components (a bond and an option), to value each component separately, and then to add the components. From the issuer's standpoint, a convert would be costly if its true value were above par value and cheap if its true value were below par value.]
Note: For the sake of simplicity ignore the impact of dilution and the sinking fund provision. In addition, to value the straight bond, we have posted the spot rates for US Government zero coupon bonds with different maturity dates (spotrates.xls). These are annual rates based on semi-annual compounding. You can assume that Flowers would command a 250 basis point premium over the default free spot rate assuming semi-annual compounding.
2. When will the holder of the convertible bond convert?
3. Should Marty Wood go forward with the convertible issue?
4. Ignore the sinking fund provision in your analysis but how would it impact on your estimate of the value of the convertible bond? Without doing it, how would you incorporate the term structure of interest rates?