Chapter 5: Q8DQ (page 622)

Explain how convertible bonds and warrants are similar and different.

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Answer

Convertible bonds convey the choice of conversion into common stock at a predefined cost during a specific period. Stock purchase warrants are given with bonds or preferred stock as a prompting to the investor, since they grant the acquisition of the organization's common stock at an expressed price .

Step by step solution

Introduction to convertible bonds-

Convertible bonds are corporate bonds that can be converted for common stock in the issuing organization. Organizations issue convertible bonds to bring down the coupon rate on debt and to postpone dilution.

Convertible bonds and warrants are similar and different-

Convertible bonds and convertible warrants are similar in that they give the security holder a future option on the common stock of the company.

Convertible bonds and warrants are dissimilar in a way that convertible bonds addresses a debt obligation of the firm. When convertible bonds is converted to common stock, corporate debt will be decreased and the capitalization will not increment of the company. A warrant is distinct as it is not a valuable instrument on its own advantages, and also the overall capitalization of the company will be increased if it is exercised.

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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

Explain how convertible bonds and warrants are similar and different.

Short Answer

Step by step solution

Introduction to convertible bonds-

Convertible bonds and warrants are similar and different-

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