ConleyCo has 10 shareholders, each of whom owns 100 of its 1,000 outstanding shares of common stock (worth $100 per share). No other stock is outstanding. Determine whether the securities described in the situations below are debt or equity of ConleyCo.

(a) ConleyCo issues a secured standard form note to the bank promising unconditionally to repay in five years $1 million borrowed, plus interest at the bank’s prime plus one percent.

(b) ConleyCo issues to the public for cash $1 million worth of “pure preferred” stock (nonvoting, nonparticipating, nonconvertible), callable in five years at par, paying an 18 percent cumulative dividend. Would it matter if the stock were callable below par or had a declining dividend?

(c) In return for a transfer of $1 million, ConleyCo issues an unsecured promissory note for $1 million to Mr. Murdock, well-known venture capitalist, payable in 10 years with interest keyed to ConleyCo's profitability. The note is subordinated to all other debt. ConleyCo could not have borrowed this amount on these terms from a bank.

(d) ConleyCo issues to the public 1,000 notes for $1,000 each, maturing in 20 years, at which time the holder will be entitled to elect to receive either $600 cash or 50 shares of ConleyCo common stock. ConleyCo can call the notes for $600 after two years, but, upon call, the holder can convert to 50 shares of stock. Interest will be paid quarterly in an amount based on ConleyCo’s common dividend, but not less than $60 per annum. The interest rate for nonconvertible unsubordinated debt in the market is l2.percent. The notes will be subordinated to all other debt.

(e) ConleyCo issues to the public $1 million in subordinated unsecured “junk bonds,” paying deferred interest resulting in an 18 percent yield to maturity, with all payments of principal and interest due in installments payable from the sixth to the fifteenth year.

Answer rating: 100% (QA)

a Payable issued to the bank is a form of debt capital b Preferred stock ... View the full answer