Colter Corporation suspended dividend payments on all four classes of capital stock outstanding because of a downturn in the economy. The four classes of stock include 7% preferred stock, cumulative, $50 par; 5% preferred stock, noncumulative, convertible, $35 par; 9% preferred stock, noncumulative, $80 par; and common stock. Fifteen thousand shares of each class of stock were outstanding. Dividends had been paid through 2005.Colter did not pay dividends in 2006 or 2007. In 2008, the economy improved, and a proposal to pay a dividend of $1.50 per share of common stock was made.
You own 100 shares of the 5%, noncumulative, convertible preferred stock and have been considering converting those 100 shares to common stock at the existing conversion rate of 3 to 1 (3 shares of common for 1 share of preferred). The rate is scheduled to drop to 2 to 1 at the end of 2008. Because the price of common stock has been rising rapidly, you are trying to decide between retaining your preferred stock or converting to common stock before the price goes higher and the ratio is lowered.
Assuming there is no conversion of preferred stock, how much cash does Colter need to pay the proposed dividend? What are the merits of converting your stock at this time as opposed to waiting until after the dividend is paid and the conversion ratio decreases? Explain the issues involved.