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Robbins Petroleum Company is four years in arrears on cumulative preferred stock dividends. There are 880,000...

Robbins Petroleum Company is four years in arrears on cumulative preferred stock dividends. There are 880,000 preferred shares outstanding, and the annual dividend is $9.50 per share. The Vice-President of Finance sees no real hope of paying the dividends in arrears. She is devising a plan to compensate the preferred stockholders for 90 percent of the dividends in arrears.

a. How much should the compensation be? (Do not round intermediate calculations. Input your answer in dollars, not millions (e.g. $1,234,000).)

b. Robbins will compensate the preferred stockholders in the form of bonds paying 12 percent interest in a market environment in which the going rate of interest is 16 percent for similar bonds. The bonds will have a 15-year maturity. Using the bond valuation Table 16-2, indicate the market value of a $1,000 par value bond. (Round your answer to the nearest whole number.)

c. Based on market value, how many bonds must be issued to provide the compensation determined in part a? (Do not round intermediate calculations and round your answer to the nearest whole number.)

Expert Solution

Annual Dividend is $9.50

4 years of arrears of dividends/ preferred share = 4 x $9.50 =$38

Total Dividend in Arrears for Robbins Petroleum Company = No. of preferred shares x Per share dividends in arrears

= 880,000 x 38

= $ 33,440,000

a. 90% of this Dividend in arrears will be compensated

= 90% x 33,440,000

= $3,0096,000

b. Market Value of Bond

Preferred stock holders will be compensated with 12% coupon paying bonds. Tenure is 15 years. The market rate is 16%. Par Value is $1000

We will use excel function of PV to calculate the market value of the bond.

Here, Rate = 16% (Bonds should yield this YTM, as this the current market rate and no investor will compromise on this yield on the bond)

Term of bond = NPER = 15 years

Coupon = PMT = 12% x Par Value = 12% x 1000 = - $120 (we will use a negative sign here, as this is a cash outflow)

Maturity Value of Bond = FV = - $1000 (The maturity amount to be paid to investors, a cash outflow for Robbins, therefore a negative sign)

Type = 0 ( 0 or ! indicates whether coupons are paid at end or beginning. 0 for end, 1 for beginning)

Market Value of Bond = PV (Present Value)

= PV(16%,15,-120,-1000,0)

= $776.98

c. Number of bonds to be issued by Robbins = Value of Compensation / Market value per unit of bond

= 3,0096,000 / 776.98

= 38734.50

~ 38,735

Robbins will have to issue 38735 bonds at $776.98

jeff jeffy answered 2 years ago

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