Exam 20: Hybrid Financing: Preferred Stock, Warrants, and Convertibles

The problem of dilution of stockholders' earnings never results from the sale of call options,but it can arise if warrants are used.

The common stock of Southern Airlines currently sells for $33,and its 8% convertible debentures (issued at par,or $1,000)sell for $850.Each debenture can be converted into 25 shares of common stock at any time before 2025.What is the conversion value of the bond?

Convertible debentures for Kulik Corporation were issued at their $1,000 par value in 2012.At any time prior to maturity on February 1,2032,a debenture holder can exchange a bond for 25 shares of common stock.What is the conversion price,P_c?

Mariano Manufacturing can issue a 25-year,8.1% annual payment bond at par.Its investment bankers also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 40% tax bracket.The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 1.0%,which would represent an after-tax risk premium.What coupon rate must be set on the preferred in order to issue it at par?

Most convertible securities are bonds or preferred stocks that,under specified terms and conditions,can be exchanged for common stock at the option of the holder.

Refer to the data for the Neuman Corporation's convertible bonds.What is the minimum price (or "floor" price)at which the Neuman's bonds should sell?

A detachable warrant is a warrant that can be detached and traded separately from the bond with which it was issued.Most traded warrants are originally attached to bonds or preferred stocks.

The owner of a convertible bond owns,in effect,both a bond and a call option.

A warrant holder is not entitled to vote,but he or she does receive any cash dividends paid on the underlying stock.

Mikkleson Mining stock is selling for $40 per share and has an expected dividend in the coming year of $2.00,and has an expected constant growth rate of 5.00%.The company is considering issuing a 10-year convertible bond that would be priced at its $1,000 par value.The bonds would have an 8.00% annual coupon,and each bond could be converted into 20 shares of common stock.The required rate of return on an otherwise similar nonconvertible bond is 10.00%.What is the estimated floor price of the convertible at the end of Year 3?

Preferred stock typically has a par value,and the dividend is often stated as a percentage of par.The par value is also important in the event of liquidation,as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.

Preferred stockholders have priority over common stockholders with respect to dividends,because dividends must be paid on preferred stock before they can be paid on common stock.However,preferred and common stockholders normally have equal priority with respect to liquidating proceeds in the event of bankruptcy.

Which of the following statements concerning warrants is correct?

Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.

Refer to the data for the Neuman Corporation's convertible bonds.What is the bond's conversion ratio?

Preissle Company,wants to sell some 20-year,annual interest,$1,000 par value bonds.Its stock sells for $42 per share,and each bond would have 75 warrants attached to it,each exercisable into one share of stock at an exercise price of $47.The firm's straight bonds yield 10%.Each warrant is expected to have a market value of $2.00 given that the stock sells for $42.What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par?

Unlike bonds,the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis.This is because dividends on preferred stock are not tax deductible,whereas interest on bonds is deductible.

Firms generally do not call their convertibles unless the conversion value is greater than the call price.

Refer to the data for the Neuman Corporation's convertible bonds.What is the bond's conversion value?

Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price,which is desirable for liquidity portfolios,and they also benefit from the 70% tax exemption on preferred dividends received.