United Technology Corporation (UTC) has $40 million of convertible bonds outstanding (40,000 bonds at $1,000 par value) with a coupon rate of 11 percent. Interest rates are currently 8 percent for bonds of equal risk. The bonds were originally sold when the average BBB rate was 12 percent, and they have 15 years left to maturity. The bonds may be called at a 9 percent premium over par as well as be converted into 30 shares of common stock. The tax rate for the company is 25 percent.

The firm's common stock is currently selling for $41 per share, and it pays a dividend of $3.50. The expected income for the company is $38 million, with 6 million shares of common stock currently outstanding.

Thoroughly analyze this bond and determine whether IMS should call the bond at the 9 percent call premium. In your analysis, consider the following:

a. The effect of the call on basic and fully diluted earnings per share and the common stock price (assume the call forces conversion).

b. The consequences of your decision on financing flexibility.

c. The net change in cash outflows to the company.

d. If the bond is called, will the shareholders take the call price or the 30 shares of common stock?

e. Assuming the bondholders could have converted the bond into common stock whenever they desired, would you as a bondholder have waited for the company to call your bond and thereby force a decision on your part? Explain.