Jackson Electronics (40% marginal tax rate) is considering issuing convertible debentures.Its investment banker tentatively has agreed to issue a 9.0 percent, 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 percent.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

The after-tax cost of debt is calculated as the interest rate multiplied by (1 - tax rate). For a 9% interest rate and a 40% tax rate, the after-tax cost is 5.4%. To achieve an 8% after-tax cost of capital, the debenture must be priced such that the effective yield to the investor is 8%. Given the conversion price and expected stock price, the minimum price per debenture that achieves this is approximately $1,033.

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