A firm wants to raise capital by issuing some securities. Its current stock price is $18. It can issue straight bond at a 10% interest rate. It also can issue convertible bonds at a 7% interest rate with face value of $1,000 and a conversion ratio of 50. The treasurer of this firm argues that convertible bond issues are the cheapest form of financing regardless of whether the company does well or poorly. Her argument is as follows. âIf the stock price falls, for instance, to $12, the convertible bonds will not be converted into common stock shares. In this case, we can pay a 7% interest rather than a 10% if we had issued straight debt. If the stock price goes up, for example, to $25, the convertible bonds would be converted. This is also great since we can effectively sell stock at higher price, $20 than the $18 stock price if we had issued equity initially. Therefore issuing convertible bonds is always better than other security issues.â How would you respond to her argument? Do you agree or disagree? Justify your answer using the data provided.
A firm wants to raise capital by issuing some securities. Its current stock price is $18. It can issue straight bond at a 10% interest rate. It also can issue convertible bonds at a 7% interest rate with face value of $1,000 and a conversion ratio of 50. The treasurer of this firm argues that convertible bond issues are the cheapest form of financing regardless of whether the company does well or poorly. Her argument is as follows. âIf the stock price falls, for instance, to $12, the convertible bonds will not be converted into common stock shares. In this case, we can pay a 7% interest rather than a 10% if we had issued straight debt. If the stock price goes up, for example, to $25, the convertible bonds would be converted. This is also great since we can effectively sell stock at higher price, $20 than the $18 stock price if we had issued equity initially. Therefore issuing convertible bonds is always better than other security issues.â How would you respond to her argument? Do you agree or disagree? Justify your answer using the data provided.
Related questions
9. Which of the following statements is NOT CORRECT?
| a | a. Owners of preferred stock have greater voting rights than common shareholders. |
| b. From an individual investor's perspective, preferred stock is riskier than bonds. | |
| c. Companies are more likely to issue preferred stock if they have a low tax bracket since preferred stock dividends are not tax deductible. | |
| d. If a preferred issue is cumulative this means that any unpaid dividends are held in arrears. |
10. As a general rule, the optimal capital structure
- Maximizes expected EPS also maximizes the price per share of common stock.
- Minimizes the interest rate on debt also maximizes the expected EPS.
- Minimizes the required rate on equity also maximizes the stock price.
- Maximizes the price per share of common stock and minimizes the WACC.
11. Which of the following statements about warrants and convertibles is NOT CORRECT?
a. The value of both warrants and convertibles depends on the stock price.
b. One primary difference between warrants and convertibles is that warrants bring in additional funds to the firm when exercised while convertibles reduce debt when exercised.
c. The coupon rate on convertible debt is higher than the coupon rate on similar straight debt because convertibles are riskier.
d. Warrants and Convertibles are used by corporations in order to get a lower rate on their debt.
12. In the lease versus buy decision, leasing is often preferable
a. if the firm is unable to borrow funds at a low rate.
b. if the firm needs a specific piece of equipment that only has value to that firm.
c. Because lease obligations do not affect the riskiness of the firm.
d. if the lessee has a higher tax rate than the lessor
13. Which statement is False?
- The WACC is the required return on the firm
