20-4 Convertible Premiums

The Tsetsekos Company was planning to finance an expansion. The principal executives of the company all agreed that an industrial company such as theirs should finance growth by means of common stock rather than by debt. However, they felt that the current $60 per share price of the company's common stock did not reflect its true worth, so they decided to sell a convertible security. They considered a convertible debenture but feared the burden of fixed interest charges if the common stock did not rise enough in price to make conversion attractive. They decided on an issue of convertible preferred stock, which would pay a dividend of $3.00 per share.

a. The conversion ratio will be 1; that is, each share of convertible preferred can be converted into a single share of common. Therefore, the convertible's par value (and also the issue price) will be equal to the conversion price, which in turn will be determined as a premium (i.e., the percentage by which the conversion price exceeds the stock price) over the current market price of the common stock What will the conversion price be if it is set at a 10% premium? At a 30% premium?

b. Should the preferred stock include a call provision? Why or why not?