Question 27

DEF Inc. has 10,000 shares of common stock outstanding. In addition, the capital structure contains $100,000 in convertible debentures, paying a 6% coupon rate. The conversion feature calls for a $40 conversion price.

Capital Structure		Income Statement
A/P	$100,000		Before Conversion	After Conversion
Long-term Debt (7%)	100,000	Sales	$200,000	$200,000
Convertible Bonds	100,000	COGS	(60,000)	(60,000)
Total Debt	$300,000	Operating Expenses	(40,000)	(40,000)
7% Preferred Stock	100,000	Operating Profits	?	?
Common: Par ($0.5)	5,000	Interest Expense	?	?
Paid-in Surplus	195,000	Taxable Income	?	?
Retained Earnings	400,000	Taxes @ 50%	?	?
Total Liabilities & Equity	$1,000,000	Income Aftertax	?	?
		Preferred Dividend	?	?
		Earnings Available to Common	?	?
		Total Shares	?	?
		Earnings Per Share	?	?

(a) Calculate Primary (before conversion) and fully-diluted Earnings per Share (EPS).

(b) Do convertibles violate the risk-return trade-off principle? What are the benefits and potential costs of convertible bonds for issuing firms?

(c) Briefly discuss the similarities and differences (at least one each) between convertible bonds and warrants.