CAF-7 · Chapter 9 · Question 9 of 15
A company issues a convertible bond. When calculating the cost of this convertible debt for the WACC, the cost is estimated as the higher of the bond's straight-debt IRR and:
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: C) The IRR of the cash flows assuming conversion into equity takes place at maturity
Explanation
For convertible bonds, investors will choose whichever option gives them the highest return at maturity (cash redemption or share conversion). The company must calculate the IRR of both scenarios and take the higher rate as its true cost of debt.
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