Robbins Petroleum Company is four years in arrears on cumulative preferred stock

Question

Robbins Petroleum Company is four years in arrears on cumulative preferred stock dividends. There are 690,000 preferred shares outstanding, and the annual dividend is $6.50 per share. the vice president of finance sees no real hope of paying the dividends in arrears. she is devising a plan to compensate the preferred stockholders for 80% of the dividends in arrears.

A. How much should the compensation be?

B. Robbins will compensate the preferred stockholders in the form of bonds paying 12% interest in a market environment in which the going rate of interest is 8% for similiar bonds. the bondsf will have a 10 year maturity. using the bond valuation table indicate the market value of a $1,000 par value bond.

C. based on market value, how many bonds must be issued to provide the compensation determined in part A? (Round to the nearest whole number).

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part A:

Compensation = Number of Shares*Dividend Per Share*Number of Years (Arrears)*% Compensated 690000*6.50*4*80%= 14352000

Answer is 14352000.

Part B:

Nper = 10*2 = 20 (indicates the period with semi-annual compounding)

Rate = 8%/2 = 4% (indicates semi-annual interest rate)

PMT = 1000*12%*1/2 = 60 (indicates the semi-annual interest payment)

FV = 1000 (indicates the face value of bonds)

PV = ? (indicates the market value of bonds)

Market Value of Bonds = PV(Rate,Nper,PMT,FV) = PV(4%,20,60,1000) = 1271.81

Answer is 1271.81.

Part C:

Number of Bonds = Compensation/Market Value of Bonds = 14352000/1271.81 = 11284.70 or 11285 bonds

Answer is 11284.70 or 11285 Bonds

Thanks.

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