Final answer:
When a convertible debenture with a nondilutive feature faces a stock dividend, its conversion ratio is adjusted to protect the investor's equity stake from dilution.
Step-by-step explanation:
If a convertible debenture has a nondilutive feature, and a stock dividend is distributed, this essentially means that the terms of the convertible debenture will be adjusted to ensure the conversion rate reflects the impact of the stock dividend, preventing dilution of the investor's potential equity stake. When a company issues a stock dividend, it is essentially dividing its existing equity into a greater number of shares, which can dilute the value of each share if convertible securities are not adjusted.
Convertible debentures are a type of debt instrument that can be converted into a specified number of shares of the issuing company's stock. A nondilutive feature is included to protect investors from events that would normally dilute the value of the converted shares, such as stock splits or stock dividends. When a stock dividend occurs, the convertible debenture's conversion ratio is recalculated to maintain the value of the holder's potential conversion, and this adjustment ensures that the convertible debenture holder is not disadvantaged by the increase in the total number of shares outstanding.
To better understand the impact on investment decisions, one must consider both potential capital gains from future sales of the stock and any dividends that might be paid out. Successful and profitable firms often have to decide between paying dividends or reinvesting profits; similarly, financial investors must decide what price they are willing to pay now for a future stream of benefits. These types of considerations underscore the complexity of applying Present Discounted Value to both stocks and bonds.