Corporate Finance
12th Edition
ISBN: 9781259918940
Author: Ross, Stephen A.
Publisher: Mcgraw-hill Education,
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Chapter 24, Problem 1MC
S&S AIR'S CONVERTIBLE BOND
Chris Guthrie was recently hired by S&S Air, Inc., to assist the company with its short-term financial planning and to evaluate the company’s performance. Chris graduated from college five years ago with a finance degree. He has been employed in the finance department of a Fortune 500 company since then.
S&S Air was founded 10 years ago by two friends, Mark Sexton and Todd Story. The company has manufactured and sold light airplanes over this period, and the company’s products have received high reviews for safety and reliability. The company has a niche market in that it sells primarily to individuals who own and fly their own airplanes. The company has two models: The Birdie, which sells for $53,000, and the Eagle, which sells for $78,000.
S&S Air is not publicly traded, but the company needs new funds for investment opportunities. In consultation with Tonisha Jones of underwriter Raines and Warren, Chris decided that a convertible bond issue with a 20-year maturity is the way to go. He met with the owners, Mark and Todd, and presented his analysis of the convertible bond issue. Because the company is not publicly traded, Chris looked at comparable publicly traded companies and determined that the average PE ratio for the industry is 17.5. Earnings per share for the company are $1.75. With this in mind, Chris concluded that the conversion price should be $45 per share.
Several days later Todd, Mark, and Chris met again to discuss the potential bond issue. Both Todd and Mark have researched convertible bonds and have questions for Chris. Todd begins by asking Chris if the convertible bond issue will have a lower coupon rate than a comparable bond without a conversion feature. Chris replies that to sell the
Mark immediately disagrees, arguing that convertible bonds are a no-win form of financing. He argues that if the value of the company stock rises to $45, the company is forced to sell stock at the conversion price. This means the new shareholders (those who bought the convertible bonds) benefit from a bargain price. Put another way, if the company prospers, it would have been better to have issued straight debt so that the gains would not be shared.
Chris has gone back to Tonisha for help. As Tonisha’s assistant, you’ve been asked to prepare another memo answering the following questions:
1. Why do you think Chris is suggesting a conversion price of $45? Given that the company is not publicly traded, docs it even make sense to talk about a conversion price?
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The founder of Frenza asks us to assist her in accounting and analysis of the corporation’s bonds, which have an annual contract rate of 8%. She wants to know the business and accounting implications of further debt issuances as she looks for ways to finance the growth of Frenza. The following Tableau Dashboard is provided to help us address her questions and provide recommendations for her business decisions.
1. Based on the current market rates for bonds of Frenza, Nelo, and Lika, which of the following bonds do lenders believe has the highest risk level?2. If Frenza decided to issue new bonds with a contract rate of 11%, would these new bonds be sold at a discount or premium based on the current market rate for Frenza bonds?3. Frenza is planning an $160,000 expansion to launch a new product line. Frenza currently earns $100,000 in net income, and the new product line will yield $50,000 in additional income before any interest expense. Frenza has three options: (1) do not expand, (2)…
John Tye has just been hired as the new corporate finance analyst at I-Ell Enterprises and has received his first assignment. John is to take the $25 million in cash received from a recent divestiture and use part of these proceeds to retire an outstanding $10 million bond issue and the remainder to repurchase common stock. However, the bond issue cannot be retired for another two years. If John can place the funds necessary to retire this $10 million debt into an account earning 6 percent compounded monthly,how much of the $25 million remains to repurchase stock?
Chapter 24 Solutions
Corporate Finance
Ch. 24 - Prob. 1CQCh. 24 - Prob. 2CQCh. 24 - Convertible Bonds and Stock Volatility Suppose you...Ch. 24 - Convertible Bond Value What happens to the price...Ch. 24 - Prob. 5CQCh. 24 - Warrants and Convertibles What is wrong with the...Ch. 24 - Warrants and Convertibles Why do firms issue...Ch. 24 - Convertible Bonds Why will convertible bonds not...Ch. 24 - Convertible Bonds When should a firm force...Ch. 24 - SS AIR'S CONVERTIBLE BOND Chris Guthrie was...
Ch. 24 - What is the floor value of the SS Air convertible...Ch. 24 - What is the conversion ratio of the bond?Ch. 24 - What is the conversion premium of the bond?Ch. 24 - What is the value of the option?Ch. 24 - Is there anything wrong with Todds argument that...Ch. 24 - Is there anything wrong with Marks argument that a...Ch. 24 - Prob. 8MCCh. 24 - During the debate, a question comes up concerning...
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