Robbins Petroleum Company is four years in arrears on cumulative preferred stock

Question

Robbins Petroleum Company is four years in arrears on cumulative preferred stock dividends. There are 780,000 preferred shares outstanding, and the annual dividend is $4.50 per share. The Vice-President of Finance sees no real hope of paying the dividends in arrears. She is devising a plan to compensate the preferred stockholders for 90 percent of the dividends in arrears.

A) How much should the compensation be?

B)

Robbins will compensate the preferred stockholders in the form of bonds paying 12 percent interest in a market environment in which the going rate of interest is 14 percent for similar bonds. The bonds will have a 15-year maturity. Using the bond valuation Table 16-2, indicate the market value of a $1,000 par value bond.

C) Based on market value, how many bonds must be issued to provide the compensation determined in part a?

Robbins will compensate the preferred stockholders in the form of bonds paying 12 percent interest in a market environment in which the going rate of interest is 14 percent for similar bonds. The bonds will have a 15-year maturity. Using the bond valuation Table 16-2, indicate the market value of a $1,000 par value bond.

C) Based on market value, how many bonds must be issued to provide the compensation determined in part a?

Explanation / Answer

A.The total dividends on preferred stock to be paid for one year = 4.50 *780,000 = $3,510,000

Since there are 4 years in arrears, the toal dividends due are = 3510000* 4 = $ 14,040,000

Since only 90% of these arrears are paid, the total dividends to be paid are = 14040000*0.9 = $12,636,000

B.The value of the bonds are caluclated as per the PV formula in MS excel

Here the FV = 1000, Coupon payment = pmt= 120, rate = 0.14 and nper =years to matrity =15 years

The present value or the market value of these bonds are given by =PV(0.14,15,120,1000) = $877.16

C. Based on the market Value, the number of bonds to be issued is 12,636,000/877.16 = 14,406 Bonds have to be issued based on the market Value

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