Exam 19: Hybrid Financing: Preferred Stock, Warrants, and Convertibles

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.

Warren Corporation's stock sells for $42 per share. The company wants to sell some 20-year, annual interest, $1,000 par value bonds. 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?

Which of the following statements concerning warrants is CORRECT?

(The following data apply to Problems 27 through 30. The problems MUST be kept together.) The following data apply to Saunders Corporation's convertible bonds: -What is the bond's conversion value?

Its investment bankers have told Donner Corporation that it can issue a 25-year, 8.1% annual payment bond at par. They 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?

Many preferred stocks extend voting rights to preferred shareholders if the preferred dividend has been omitted for some specified period, for example, 4 quarters.

Which of the following statements is most CORRECT?

Chocolate Factory's convertible debentures were issued at their $1,000 par value in 2009. At any time prior to maturity on February 1, 2029, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?

Which of the following statements about convertibles is most CORRECT?

A convertible debenture can never sell for more than its conversion value or less than its bond value.

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

Orient Airlines' common stock 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 2019. What is the conversion value of the bond?

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

The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock.

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.

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

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

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.

A warrant is an option, and as such it cannot be used as a "sweetener."

Valdes Enterprises 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%. The stock currently sells for $40.00 a share, has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 5.00%. What is the estimated floor price of the convertible at the end of Year 3?