What method of “bond repayment” reduces debt and increases the amount of common stock outstanding? (LO16-3)

Short Answer

Expert verified

The conversion method of bond repayment increases the common stock.

Step by step solution

01

Bond repayment

Bond repayment refers to how a corporation repays its outstanding bonds through various methods such as serial payments and sinking funds provisions.

02

Repayment method that increases the common stock

The conversion method reduces the debts and simultaneously increases the amount of outstanding common stock.

Under this method, bonds are converted into common stocks.

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Most popular questions from this chapter

Question: Barton Simpson, the chief financial officer of Broadband Inc. could hardly believe the change in interest rates that had taken place over the last few months. The interest rate on A2 rated bonds was now 6 percent. The $30 million, 15-year bond issue that his firm has outstanding was initially issued at 9 percent five years ago. Because interest rates had gone down so much, he was considering refunding the bond issue. The old issue had a call premium of 8 percent. The underwriting cost on the old issue had been 3 percent of par, and on the new issue it would be 5 percent of par. The tax rate would be 30 percent and a 4 percent discount rate would be applied for the refunding decision. The new bond would have a 10-year life. Before Barton used the 8 percent call provision to reacquire the old bonds, he wanted to make sure he could not buy them back cheaper in the open market.

d. In terms of the refunding decision, how should Barton be influenced if he thinks interest rates might go down even more?

Discuss the relationship between the coupon rate (original interest rate at time of issue) on a bond and its security provisions. (LO16-1)

Kevin’s Bacon Company Inc. has earnings of \(9 million with 2,100,000 shares outstanding before a public distribution. Seven hundred thousand shares will be included in the sale, of which 400,000 are new corporate shares, and 300,000 are shares currently owned by Ann Fry, the founder and CEO. The 300,000 shares that Ann is selling are referred to as a secondary offering, and all proceeds will go to her.

The net price from the offering will be \)16.50, and the corporate proceeds are expected to produce $1.8 million in corporate earnings.

a. What were the corporation’s earnings per share before the offering?

b. What are the corporation’s earnings per share expected to be after the offering?

Do corporations rely more on external or internal funds as sources of financing?

Question: The Bailey Corporation, a manufacturer of medical supplies and equipment, is planning to sell its shares to the general public for the first time. The firm’s investment banker, Robert Merrill and Company, is working with Bailey Corporation in determining a number of items. Information on the Bailey Corporation follows:

Bailey corporation

Income statement

For the year 20X1

Sales (all on credit)

\(42,680,000

Cost of goods sold

\)32,240,000

Gross profit

\(10,440,000

Selling and administrative expenses

\)4,558,000

Operating profit

\(5,882,000

Interest expense

\)600,000

Net income before taxes

\(5,282,000

Taxes

\)2,120,000

Net income

\(3,162,000

Bailey corporation

Balance sheet

As of December 31, 20X1

Assets

Current assets:

Cash

\)250,000

Marketable securities

\(130,000

Accounts receivables

\)6,000,000

Inventory

\(8,300,000

Total current assets

\)14,680,000

Net plant and equipment

\(13,970,000

Total assets

\)28,650,000

Liabilities and stockholders’ equity

Current liabilities:

Accounts payable

\(3,800,000

Notes payable

\)3,550,000

Total current liabilities

\(7,350,000

Long-term liabilities

\)5,620,000

Total liabilities

\(12,970,000

Stockholder’s equity:

Common stock (1,800,000 shares at \)1 par)

\(1,800,000

Capital in excess of par

\)6,300,000

Retained earnings

\(7,580,000

Total stockholder’s equity

\)15,680,000

Total liabilities and stockholder’s equity

$28,650,000

a. Assume that 800,000 new corporate shares will be issued to the general public. What will earnings per share be immediately after the public offering? (Round to two places to the right of the decimal point.) Based on the price-earnings ratio of 12, what will the initial price of the stock be? Use earnings per share after the distribution in the calculation.

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