The Tsetsekos Company was planning to finance an expansion. The principal executives of the company all agreed that an industrial company such as theirs should finance growth by means of common stock rather than by debt. However, they felt that the current $42 per share price of the company's common stock did not reflect its true worth, so they decided to sell a convertible security. They considered a convertible debenture but feared the burden of fixed interest charges if the common stock did not rise enough in price to make conversion attractive. They decided on an issue of convertible preferred stock, which would pay a dividend of $2.10 per share.

The Tsetsekos Company was planning to finance an expansion. The principal executives of the company all agreed that an industrial company such as theirs should finance growth by means of common stock rather than by debt. However, they felt that the current $42 per share price of the company's common stock did not reflect its true worth, so they decided to sell a convertible security. They considered a convertible debenture but feared the burden of fixed interest charges if the common stock did not rise enough in price to make conversion attractive. They decided on an issue of convertible preferred stock, which would pay a dividend of $2.10 per share.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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You are an accountant for Taos Company, which has two items of long-term convertible debt on its balance sheet. Taos's president calls you into his office and says, "We are too leveraged. So, you remember that convertible debt we issued at the beginning of the year? Let's figure out the value of the conversion feature and assign that to equity so that we can reduce the amount we report as debt. And I have also been thinking about that convertible debt we issued at par 5 years ago. If you remember, each $1,000 bond is convertible into 25 shares. Now that our shares are trading at $70, obviously that is no longer debt. So let's classify that debt as equity now." Required: From financial reporting and ethical perspectives, discuss the issues raised by this situation.

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