Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250



Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

CONVERTIBLES In the summer of 2018, the Gallatin Company was planning to finance an expansion with a convertible security. It considered a convertible debenture but feared the burden of fixed interest charges if the common stock price did not rise enough to make conversion attractive. The firm decided on an Issue of convertible preferred stock, which would pay a dividend of $1.07 per share.

The common stock was selling for $21 a share at the time. Management projected earnings for 2018 at $1.40 a share and expected a future growth rate of 12% per year in 2019 and beyond. Tire investment bankers and management agreed that the common stock would continue to sell at 15 times earnings, the current price/earnings ratio.

  1. a. What conversion price should the Issuer set? The conversion rate will be 1.0; that is, each share of convertible preferred can be converted into 1 share of common. Therefore, the convertible's par value (as well as the issue price) will be equal to the conversion price, which in turn will be determined as a percentage over the current market price of the common. Your answer will be a guess, but it should be a reasonable one.
  2. b. Should the preferred stock include a call provision? Why or why not?


Summary Introduction

To Determine: The conversion price the issuer needs to set.

Introduction: A conversion price is the price at which a particular convertible security is converted into a common stock. The conversion price is determined when the security is issued. The quantity of shares to be expected is the principal measure of the security which is divided by the conversion price.


Determine the conversion price

The investment bankers occasionally utilize the dependable guideline that, to fill in as a premium over the current cost that ought to be in the series somewhere in the range of 20% and 30%. Because the stock has a shown increment in income of 12% every year, a great contention could be made for setting the premium close to the midpoint of the range with 25%. Based on assumption, a premium of 25% result in the conversion cost of $26.25. There has been substantial utilization of 20% to 30% premiums as of late.



Summary Introduction

To Determine: Whether the preferred stock include a call provision

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