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Chapter 16: 5Q (page 873)

Explain how the conversion feature of convertible debt has a value (a) to the issuer and (b) to the purchaser.

Short Answer

Expert verified

(a) For the issuer, lower cash revenue cost on account of nonconvertible obligation, lead to rise in capital value over long run

(b) Gives purchaser choice to get either the face measure of obligation upon development or indicated number of offers upon change, assuming business sector benefit of basic normal stock increments over the transformation value, the buys get advantages of appreciation.

Step by step solution

01

Elaborating the value of conversion feature of convertible debt to the issuer

(a) According to the view of the issuer, the conversion element of convertible debt results about a lower cash revenue cost than on account of nonconvertible obligation. Moreover, the issuer in arranging its long-range financing might see the convertible obligation of raising value capital over the long haul. Hence, if the market worth of basic normal stock increments adequately after the issue of the obligation, investors can generally compel change of the convertible debt into common stock by calling the issue for redemption.

02

Elaborating the value of conversion feature of convertible debt to the purchaser

(b) The purchaser acquires a choice to get either the face amount of debt upon maturity or the predefined number of common shares upon conversion. On the off chance that the market worth of fundamental common stock increments over the conversion price, the buyer (either through transformation or through holding the convertible obligation containing the change choice) gets the advantages of appreciation. Then again, should the worth of the basic organization stock not increment, the buyer can in any case hope to get the head and (lower) interest.

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Most popular questions from this chapter

CA16-5 (EPS: Preferred Dividends, Options, and Convertible Debt) 鈥淓arnings per share鈥� (EPS) is the most featured, single financial statistic about modern corporations. Daily published quotations of stock prices have recently been expanded to include for many securities a 鈥渢imes earnings鈥� figure that is based on EPS. Stock analysts often focus their discussions on the EPS of the corporations they study.

Instructions

(a) Explain how dividends or dividend requirements on any class of preferred stock that may be outstanding affect the computation of EPS.

(b) One of the technical procedures applicable in EPS computations is the 鈥渢reasury-stock method.鈥� Briefly describe the circumstances under which it might be appropriate to apply the treasury stock method.

(c) Convertible debentures are considered potentially dilutive common shares. Explain how convertible debentures are handled for purposes of EPS computations.

The information below pertains to Barkley Company for 2018.

Net income for the year \(1,200,000

7% convertible bonds issued at par (\)1,000 per bond); each bond is convertible into

30 shares of common stock 2,000,000

6% convertible, cumulative preferred stock, \(100 par value; each share is convertible

into 3 shares of common stock 4,000,000

Common stock, \)10 par value 6,000,000

Tax rate for 2018 40%

Average market price of common stock \(25 per share

There were no changes during 2018 in the number of common shares, preferred shares, or convertible bonds outstanding. There is no treasury stock. The company also has common stock options (granted in a prior year) to purchase 75,000 shares of common stock at \)20 per share.

Instructions

(a) Compute basic earnings per share for 2018.

(b) Compute diluted earnings per share for 2018

Four years after issue, debentures with a face value of \(1,000,000 and book value of \)960,000 are tendered for conversion into 80,000 shares of common stock immediately after an interest payment date. At that time, the market price of the debentures is 104, and the common stock is selling at \(14 per share (par value \)10). The company records the conversion as follows. Bonds Payable 1,000,000 Discount on Bonds Payable 40,000 Common Stock 800,000 Paid-in Capital in Excess of Par鈥� Common Stock 160,000 Discuss the propriety of this accounting treatment.

(EPS with Stock Dividend and Discontinued Operations) Christina Corporation is preparing the comparative financial statements to be included in the annual report to stockholders. Christina employs a fiscal year ending May 31.

Income from operations before income taxes for Christina was \(1,400,000 and \)660,000, respectively, for fiscal years ended May 31, 2018 and 2017. Christina experienced a loss from discontinued operations of \(400,000 on March 3, 2018. A 40% combined income tax rate pertains to any and all of Christina Corporation鈥檚 profits, gains, and losses.

Christina鈥檚 capital structure consists of preferred stock and common stock. The company has not issued any convertible securities or warrants and there are no outstanding stock options.

Christina issued 40,000 shares of \)100 par value, 6% cumulative preferred stock in 2014. All of this stock is outstanding, and no preferred dividends are in arrears.

There were 1,000,000 shares of \(1 par common stock outstanding on June 1, 2016. On September 1, 2016, Christina sold an additional 400,000 shares of the common stock at \)17 per share. Christina distributed a 20% stock dividend on the common shares outstanding on December 1, 2017. These were the only common stock transactions during the past 2 fiscal years.

Instructions

(a) Determine the weighted-average number of common shares that would be used in computing earnings per share on the current comparative income statement for:

(1) The year ended May 31, 2017.

(2) The year ended May 31, 2018.

(b) Starting with income from operations before income taxes, prepare a comparative income statement for the years ended May 31, 2018 and 2017. The statement will be part of Christina Corporation鈥檚 annual report to stockholders and should include appropriate earnings per share presentation.

(c) The capital structure of a corporation is the result of its past financing decisions. Furthermore, the earnings per share data presented on a corporation鈥檚 financial statements is dependent upon the capital structure.

(1) Explain why Christina Corporation is considered to have a simple capital structure.

(2) Describe how earnings per share data would be presented for a corporation that has a complex capital structure.

(Stock-Based Compensation) Assume that Amazon.com has a stock-option plan for top management. Each

stock option represents the right to purchase a share of Amazon \(1 par value common stock in the future at a price equal to the

fair value of the stock at the date of the grant. Amazon has 5,000 stock options outstanding, which were granted at the beginning

of 2017. The following data relate to the option grant.

Exercise price for options \)40

Market price at grant date (January 1, 2017) \(40

Fair value of options at grant date (January 1, 2017) \)6

Service period 5 years

Instructions

(a) Prepare the journal entry(ies) for the first year of the stock-option plan.

(b) Prepare the journal entry(ies) for the first year of the plan assuming that, rather than options, 700 shares of restricted

stock were granted at the beginning of 2017.

(c) Now assume that the market price of Amazon stock on the grant date was $45 per share. Repeat the requirements for

(a) and (b).

(d) Amazon would like to implement an employee stock-purchase plan for rank-and-file employees, but it would like to

avoid recording expense related to this plan. Which of the following provisions must be in place for the plan to avoid

recording compensation expense?

(1) Substantially all employees may participate.

(2) The discount from market is small (less than 5%).

(3) The plan offers no substantive option feature.

(4) There is no preferred stock outstanding
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