The Nelson Corporation currently has an EBIT level of $20 million. The firm has 10 million shares. of common stock outstanding and no interest-bearing debt.
The firm's tax rate is 50 percent, and Nelson's common stock price-earnings
(P/E) ratio is 10. To finance new investments, the company plans to issue
$5 million worth of $1,000 par value, 8 percent convertible bonds. The con-
version, price on the bonds will be set at 25 percent above current stock price.
a. Determine the conversion ratio.
b.
Calculate how many shares of new stock will be issued if all the bonds are
converted.
c. If Nelson's EBIT increases by $1 million next year because of the new in-
vestments, determine the firm's earnings per share for next year with con-
version (and therefore no interest charges) and without conversion.
d.
Assuming the firm's P/E. ratio increases to 12, and assuming no conversions
had occurred, what would the stock price be in (c)?