3. Is there anything wrong with Mark’s argument that a convertible bond is a bad idea because it allows new shareholders to participate in gains made by the company? Pinjarra Air is preparing its first public securities offering. In consultation with Renata Harper of underwriter Raines and Warren, Chris Guthrie decided that a convertible bond with a 20-year maturity was the way to go.

He met the owners, Mark and Todd, and presented his analysis of the convertible bond issue. Because the company is not publicly traded, Chris looked at comparable publicly traded companies and determined that the average PE ratio for the industry is 14.5. Earnings per share for the company are $1.30. With this in mind, Chris has suggested a conversion price of $25 per share.

Several days later, Todd, Mark and Chris met again to discuss the potential bond issue. Both Todd and Mark had researched convertible bonds and they had some questions for Chris. Todd began by asking Chris if the convertible bond issue would have a lower coupon rate than a comparable bond without a conversion feature. Chris informed him that a face value convertible bond issue would require a 4 per cent coupon rate with a conversion value of

$800, while a plain vanilla bond would have a 7 per cent coupon rate. Todd nodded in agreement and explained that the convertible bonds are a winwin form of financing. He further explained that if the value of the company shares did not rise above the conversion price, the company would be issuing debt at a cost below the market rate (4 per cent instead of 7 per cent). If the company’s shares did rise to the conversion value, on the other hand, the company would be effectively issuing shares at a price above the current value.