Jackson Electronics (40% marginal tax rate) is considering issuing convertible debentures. Its investment banker tentatively has agreed to issue a 9.0%, 20-year convertible debenture ($1,000 par value). The conversion price will be $50 a share. Jackson's financial managers only want to issue the convertible if its after-tax component cost of capital is less than or equal to 8.0%. Otherwise, they plan to issue non-convertible debt. Jackson's current common stock price is $43 a share. The company expects to call the convertible issue 5 years from now when the common stock price is expected to be $60 a share. Under the conditions given in this problem, what is the minimum price per debenture that Jackson can receive and keep the after-tax cost of capital for the debentures at 8.0%?

Question

Quizplus · Accepted Answer

To find the minimum price per debenture, calculate the after-tax cost of debt and compare it to the required 8.0%. The after-tax cost of debt is 9.0% * (1 - 0.40) = 5.4%. To achieve an 8.0% after-tax cost of capital, the debenture must be priced such that the yield to maturity (YTM) equals 8.0%. Given the conversion feature and expected stock price increase, the debenture's price must be higher than par value, approximately $1,033, to meet the required cost of capital.

Jackson Electronics (40% Marginal Tax Rate) Is Considering Issuing Convertible