The International Supplies Company (ISC) has convertible preferred stocks tradin

Question

The International Supplies Company (ISC) has convertible preferred stocks trading at $80 and serving an annual dividend of $2.40. The preferred is convertible into two shares of ISC common stocks. Shares of common stock are currently trading at $32.

a. What is the conversion ratio of the convertible preferred?

b. What is the conversion price of a share of common stock?

c. What is the conversion premium?

d. What is the conversion value of the convertible preferred?

e. What is the value of the preferred if it were of convertible? If ISC had issued its preferred without the option to convert them into common stocks it would have offered an annual dividend of $2.72 instead of $2.40.

f. What is the value of the option to convert the preferred shares into common stocks?

Explanation / Answer

(a) Conversion ratio (CR) = 2:1 = 2

(b) Conversion price (CP) = $80 / 2 = $40

(c) Conversion premium = CP - Current stock price = $(40 - 32) = $8

(d) Conversion value (CV) = Common stock price x CR = $32 x 2 = $64

Note: First 4 sub-parts are answered.

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