Convertibility, Calls, And Valuation Of Bonds And Stock

Convertibility, Calls, and Valuation of Bonds and Stock, and Dividend Policy

Dory Your L Hi Okfu9could Be Convertible Into 32 S

Dory Your L Hi Okfu9could Be Convertible Into 32 S

Do.,.rY Y^:.,^,o",,",!,''u r-l hi okfu9 could be convertible into 32 shares of stock). Coupon payments will be made annually. The bonds will be noncallable for 5 years, after which they will be callable at a price of 91,090; this call price would decline by $6 per year in Year 6 and each year thereafter. For simplicity, assume that the bonds may be called or converted only at the end of a year, immediately after the coupon and dividend payments. Management will call the bonds when their conversion value exceeds 25o/o of thetr par value (not their call price). a.

For each year, caiculate (1) the anticipated stock price, (2) the anticipated conversion value, (3) the anticipated straight-bond price, and (4) the cash flow to the investor asstrming conversion occurs. At what year do you expect the bonds will be forced into conversion with a call? What is the bond's value in conversion when it is converted at this time? What is the cash flow to the bondholder when it is converted at this time? (Hint: The cash flow includes the conversion value and the coupon payment, because the conversion occurs immediately after the coupon is paid.) b. What is the expected rate of return (i.e., the before-tax component cost) on the proposed convertible issue? c.

Assume that the convertible bondholders require a 9o/o rale of return. If the coupon rate remains unchanged, then what conversion ratio will give a bond price of $1,000? Paul Duncan, financiai manager of EduSoft Inc., is facing a dilemma. The firm was founded 5 years ago to provide educational software f

To surwive, EduSoft must grab market share now, and this will require a large infusion of new capital. Because he expects earnings to continue rising sharply and looks for the stock price to follow suit, Mr. Duncan does not think it lvould be wise to issue new common stock at this time. On the other hand, interest rates are currently high by historical standards, and the firm's B rating means that interest payments on a nerv debt issue nould be prohibitive. Thus, he has narrowed his choice offinancing alternatives to (l) preferred stock, (2) bonds with warrants, or (-l) convertible bonds.

As Duncan's assistant, you have been asked to help in the decision process by ansu,ering the following questions. a. How does preferred stock differ from both common equity and debt? Is preferred stock more risky than common stock? What is floating rate preferred stock? b. How can knowledge of call options help a financial manager to better understand warrants and convertibles? c.

Mr. Duncan has decided to eliminate preferred stock as one of the alternatives and focus on the others. EcluSoll's investment banker estimates that EduSoft could issue a bond-with-warrants package consisting of a 2O-year bond and 27 warrants. Each warrant would have a strike price of $25 and l0 years until expiration. It is estimated that each rvarrant, when detached and traded separately, would have a value of $5.

The coupon on a similar bond but without warrants would be 10%. (l) What coupon rate should be set on the bond with warrants if the total package is to sel1 at par ($1,000)? (2) When would you expect the warrants to be exercised? What is a stepped-up exercise price? (3) Will the warrants bring in additional capital when exercised? If EduSoft issues 100,000 bond-with-warrant packages, how much cash will EduSoft receive when , ktl Do a- anL b Part 6 Cash Distributions and Capital Structure Investors are more concerned with future dividends than historical dividends, s

What do analysts expect MSFT's payout policy to be in the future? Refer back to the FULL COMPANY REPORT, and scroll down to the 5 Yr Annual Balance Sheet section. Does it appear that MSFT has been repurchasing any stock, or has it been issuing new stock? Integrated Waveguide Technologies, Inc. (IWT) is a 6-year-old company founded by Hunt |ackson and David Smithfield to exploit metamaterial plasmonic technology to dwelop and manufacture miniature microwave frequenry directionai transmitters and receivers for use in mobile Internet and communications applications" fWT's technology, although highly advanced, is relatively inexpensive to implement, and its patented manufacturing techniques requke little capital as compared to many electronics fabrication ventures.

Because of the low capital requirement, Jackson and Smithfield have been able to avoid issuing new stock and thus own ali of the shares. Because of the explosion in demand for its mobile Internet applications, IWT must now access outside equity capital to fund its growth, and |ackson and Smithfield have decided to take the company public. Until now, |ackson and Smithfield have paid themselves reasonable salaries but routinely reinvested all after-tax earnings in the firm, so dividend policy has not been an issue. However, before talking \Mith potential outside investors, they must decide on a dividend policy. Your new boss at the consulting firm Flick and Associates, which has been retained to help IWT prepare for its public offering has asked you to make a presentation to laclson and Smithfield in which you review the theory of dividend policy and discuss the following issues. a. (1) What is meant by the term "distribution policy"?

How has the mix of dividend payouts and stock repurchases changed over time? (2) The terms "irrelevance," "dividend preference," or "bird-in-the-hand," and "tax effect" have been used to describe three major theories regarding the way dividend payouts affect a firm's value. Explain these terms, and briefly describe each theory. (3) What do the three theories indicate regarding the actions management should take with respect to dividend payouts? (a) What results have empirical studies of the dividend theories produced? How does all this affect what we crln tel1 managers about dividend payouts? b. Discuss (1) the information content, or signaling, hlpothesis, (2) the clientele effect, and (3) their effects on distribution poliry. c. (1) Assume that IWT has completed its IPO and has a $112.5 million capital budget planned for the coming year.

You have determined that its present capital structure (80% equity and.ZAo/o debt) is optimal, and its net income is forecasted at $140 million. Use the residual distribution approach to determine IWT's total dollar distribution. Assume for now that the distribution is in the form of a dividend. Suppose IWT has 100 million shares of stock outstanding. What is the forecasted dividend payout ratio?

What is the forecasted dividend per share? What would happen to the payout ratio and DPS if net income were forecasted to decrease to $90 million? To increase to $160 million? u5 nz nz The assignment involves analyzing complex financial instruments, corporate finance decisions, and strategic dividend policies in various firms, supported by theoretical frameworks and practical calculations, to inform managerial decision-making and investment strategies.