Question

Teller Pen is engaged in the manufacture of mechanical pens and pencils, porous pens, and a recently developed line of disposable lighters. Since the firm sells to a great many distributors, and its products are all considered nondurable consumer goods, sales are relatively stable. The current price of the company’s stock, which is listed on the New York Stock Exchange, is $25. The most recent earnings and dividends per share are $3,10 and $1.50, respectively. The rate of growth in sales, earnings, and dividends in the past few years has averaged 5 percent. Teller Pen has total assets of $400 million. Current liabilities, which consist primarily of accounts payable and accruals are $28 million, long-term debt of $83 million; and common equity totals $289 million. An additional $33 million of external funds is required to build and equip a new disposable lighter manufacturing complex in central Ohio and to supply the new facility with working capital.

Choose the correct financing method.

A. Convertible Debenture

B. Preferred Stock (nonconvertible)

Answer 1

Preferred Stock (nonconvertible) should be preferred over Convertible Debenture. The reason behind choosing this method of financing the project is that it is more cheaper and does not reduce the controlling interst of existing shareholders in the company. Here reason behind cheaper to preferred stock is not the interest rate but the fact that company have to redeem both preferred stock and debenture on due date but debenture holder will have the option to convert there debt into equity on redemption and they will convert it in equity if product is successfull and share price of the company increases. This will give them dual benefit of interest payment throughout the period and participation in capital appreciation on redemption. Whereas in case of preferred stock they get only fix coupon payment and fixed amount on redemption.

Secondly Preferred Stock (nonconvertible) does not reduce the controlling interst of existing shareholders in the company. As they do not stand a chance to convert there shares into equity on redemption. So, this will also give the benefit to existing shareholder to have there share value appreciated if the project is successfull. Hence Preferred Stock (nonconvertible) should be chosen as a financing method.