Firm wants to raise capital by issuing some securities

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Reference no: EM131544061

A firm wants to raise capital by issuing some securities. Its current stock price is $18. It can issue straight bond at a 10% interest rate. It also can issue convertible bonds at a 7% interest rate with face value of $1, 000 and a conversion ratio of 50. The treasurer of this firm argues that convertible bond issues are the cheapest form of financing regardless of whether the company does well or poorly. Her argument is as follows.

"If the stock price falls, for instance, to $12, the convertible bonds will not be converted into common stock shares. In this case, we can pay a 7% interest rather than a 10% if we had issued straight debt. If the stock price goes up. for example, to $25, the convertible bonds would be converted. This is also great since we can effectively sell stock at higher price. S20 than the SI 8 stock price if we had issued equity initially. Therefore issuing convertible bonds is always better than other security issues."

How would you respond to her argument? Do you agree or disagree? Justify your answer using the data provided.

Reference no: EM131544061

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