The Rambutan Fruit Company needs to raise $10 million by means of a debt issue. It has the following two alternatives: a 20-year, 8 percent convertible debenture issue with a $50 conversion price and $1,000 face value; or a 20-year, 12 percent straight debt issue. Each $1,000 bond has a detachable warrant to purchase four shares of stock for a total of $200. The company has a 40 percent tax rate, and its stock is currently selling at $40 per share. Its net income before interest and taxes is a constant 20 percent of its total capitalization, which currently appears as follows:
Common stock (par $5)………………………………. $ 5,000,000
Additional paid-in capital…………………………….. 10,000,000
Retained earnings…………………………………….. 15,000,000
Total capitalization……………………………………$30,000,000
a. Show the capitalization from each alternative, both before and after conversion or exercise (a total of four different capitalizations).
b. Compute earnings per share currently and under each of the four capitalization determined in Part (a).
c. If the price of Rambutan stock went to $75, determine the theoretical value of each warrant issued under the second alternative.