The Acme company has decided to offer shareholders Unbundled Stock Units (USUs). How they work is, in exchange for one share of common stock of Acme (currently valued at $25), a shareholder can elect to receive a package consisting of:

One bond that will have a coupon equal to $1.00 per year, paid at the end of each year for 10 years, and that will pay off at $10.00 at the end of 10 years.

One share of preferred stock that initially will have no dividend but will receive any common stock dividend increase—that is, it will have a dividend equal to the excess of Acme’s future common stock dividend over the $1.00 current dividend amount. Acme has no specific policy of increasing common stock dividends, but the consensus analyst forecast is that dividends will grow at 8 percent per year over the foreseeable future to be paid at the end of each of the next 10 years, at which time the preferred stockholders will receive a payoff of $5.00 per share and must return the preferred stock to Acme.

One "equity participation unit" that will receive no cash flows over its life. At the end of its life, in 10 years, it can be submitted to Acme along with $15.00 (note how this $15 is enough to pay off the bond and preferred stock) in return for one share of Acme’s common stock.

This allows investors to “unbundle” and sell pieces as they would like. They may choose to just hold bonds (lower risk) and sell the stock and participation unit. Can you figure out what each piece of the USU is worth? Start as follows:

Assuming the market requires a 9 percent per annum return on Acme’s bonds as described in the first bullet point above, what is one of those bonds worth today?

Assuming the market requires a 10 percent return on the preferred stock as described in the second bullet point above, what is one share of the preferred stock worth today?

What is your best guess as to the value of an equity participation unit? Why?

Answer rating: 100% (QA)

The bond is worth 10109 917 This is because the bond pays 1 per year in inte... View the full answer