Question

The Tsetsekos Company was planning to finance an expansion. The principal executives of the company all agreed that an industrial company such as theirs should finance growth by means of common stock rather than by debt. However, they felt that the current $49 per share price of the company's common stock did not reflect its true worth, so they decided to sell a convertible security. They considered a convertible debenture but feared the burden of fixed interest charges if the common stock did not rise enough in price to make conversion attractive. They decided on an issue of convertible preferred stock, which would pay a dividend of $2.10 per share.

a. The conversion ratio will be 1.0; that is, each share of convertible preferred can be converted into a single share of common. Therefore, the convertible's par value (and also the issue price) will be equal to the conversion price, which in turn will be determined as a premium (i.e., the percentage by which the conversion price exceeds the stock price) over the current market price of the common stock. What will the conversion price be if it is set at a 14% premium? Round your answer to the nearest cent.

At a 20% premium? Round your answer to the nearest cent.

Answer 1

The conversion price is part of determining the number of shares to be received upon conversion. If shares never close above the conversion price, the convertible bond is never converted to common shares. Usually, the conversion price is set at a significant amount higher than the current price of the common stock to make conversion desirable only if a company's common shares experience a significant increase in value. The conversion price is set by management as part of the conversion ratio before the convertibles are issued to the public. The conversion ratio is the par value of the convertible security divided by the conversion price.

The Conversion ratio is 1:1

Current market price       =$49

Dividend payable on convertible stock =$2.1

the convertible's par value (and also the issue price) will be equal to the conversion price

Conversion price should be set at a 14% premium over the current market price

Conversion price =         49 +14% =$55.86 = $56

The share price should go higher than $56 to convert into equity

the convertible's par value (and also the issue price) will be equal to the conversion price

Conversion price should be set at a 20% premium over the current market price

Conversion price =         49 +20% =$58.8 = $59

The share price should go higher than $59 to convert into equity