Three years ago you bought 100 shares of Pike Company’s convertible preferred st

Question

Three years ago you bought 100 shares of Pike Company’s convertible preferred stock at $50 per share. The preferred stock had an annual dividend of $2.85 per share, and a total of $7.45 in dividends per share have been paid so far. Today the company announced that the stock is redeemable for $54.25 plus accrued and unpaid dividends, for a total of $55.35. Alternatively, holders may convert their shares of preferred stock at a conversion rate of 1.05 shares of Pike Company’s common stock for each share of preferred stock. If the closing price of Pike Company’s common stock is $54.00, what is your holding period return based on your optimal decision?

Explanation / Answer

Answer:

Calculation of Holding period return :

Case 1: IF Preferred share are redeemed:

Holding Period Return = [Dividend Income + (End of Period Value – Initial Value)] / Initial Value

= [(100*2.85*3) + (100*54.25 – 100*50)] / (100*50)

= (855 + 425) /5000

= 0.256

=25.60%

Case 2: IF Preferred share are Converted :

Holding Period Return = [Dividend Income + (End of Period Value – Initial Value)] / Initial Value

= [(100*2.85*2) + (100*1.05*54 – 100*50)] / (100*50)

= (570 + 670) /5000

= 0.248

= 24.80%

Case 1 has higher Return.

Hence its better to redeem preference shares

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