Question

Convertible preferred stock Valerian Corp. convertible preferred stock has a fixed conversion ratio of 5 common shares per 1 share of preferred stock. The preferred stock pays a dividend of ​$10.00 per share per year. The common stock currently sells for ​$20 per share and pays a dividend of ​$1.00 per share per year.

a. On the basis of the conversion ratio and the price of the common​ shares, what is the current conversion value of each preferred​ share? b. If the preferred shares are selling at ​$9696 ​each, should an investor convert the preferred shares to common​ shares?
c. What factors might cause an investor not to convert from preferred to common​ stock?

Answer 1

Step-by-step explanation:

a. On the basis of the conversion ratio and the price of the common shares, what is the current conversion value of each preferred share?

Conversion Value = No of Common Shares × Market Price Per Share

= 5 × $20

= $100

b. If the preferred shares are selling at $9696 each, should an investor convert the preferred shares to common shares?

Total Value of preferred Share = Share Price + Dividend Payment Per Share

= $9696 + $10

= $ 9706

Total Value of 5 Common Stock = ((Market Price of 1 Share + Dividend per Share) × 5)

= ((20 + 1) × 5)

= $ 105

No. The investor should not convert the preferred shares to common shares. This is because, the value of one preferred share exceeds the value of the converted common shares by $9601. Thus, based on the value of the converted and non-converted preferred share, the non-converted preferred share is more valuable than the converted one. Thus, the investor should not convert the preferred shares.

c. What factors might cause an investor not to convert from preferred to common stock?

If the value of the converted shares is lower than that of the original preferred share, it makes the conversion devalue an investor's overall investment value.

Additionally, if the investor is unwilling to have residual claim on profits. This is because common stockholders receive their dividends after debt and preference shareholders get their claims. Therefore, the preferred shareholder could see it best to retain their holdings as Preferred and not Common.