Convertible Preference Shares

No. Although the statement is correct that Kol's payment priority would be reduced once the conversion was executed, this is not a grave concern to Kol. In fact, since common equity holders are paid last or not at all, this view proves to be a worse position for Grand.

Consider a company named Grand Enterprises that invested in 1,000 no par value convertible preference shares (conversion at 20:1) at $88 per share and holds them for the required time. When do you suppose it makes sense to consider converting if common shares are currently valued at $3.00 per share?

Yes, correct. For example, if Kol is ready to report earnings per share (EPS) of $5.00 because net earnings are $50,000 and common shares are 10,000, when Kol has even a 1% change in common shares outstanding – 100 more, its earnings per share decreases to $4.95.

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No. Kol is not most interested in the number of votes of common shares increasing, but it is interested in the number of shares outstanding that represent votes.

Yes, correct. The current convertible preference portfolio of shares is worth 1,000 shares x $88 per share, or $88,000. Note that the conversion ratio given is 20:1. The break-even conversion point is at $4.40 per share because 1,000 shares x 20 is 20,000 shares of common stock that would be owned. For the common share portfolio to be equal to or greater than $88,000, the share price is $88,000 divided by 20,000, or $4.40 per share. This does not mean that Grand Enterprises must convert or that they definitely will; it only means that the conversion provides equilibrium at the common share price of $4.40 per share.

No. The common share price does not need to climb anywhere as high as preference share prices are. Consider that each type of equity provides a risk/return structure, and that the two share prices do not need to be within a certain percentage of each other. Preference shares remain at par value while the market dictates the price of common shares based on future expected cash flows to investors.

No. The convertible preference share's value will not go below its par value.

Consider the view from the issuing company. Kol Products issued 1,000 shares no par value convertible preference shares at $88 per share to Grand Enterprises. The company is doing very well financially, and earnings look like they are reaching an all-record high this year. The market price for common shares reflects this, and the price has started to climb. What reason do you think best represents why Kol Products would not want Grand to convert their shares to common shares?

When someone hears about a "convertible," a vision may pop into mind of driving on an open roadway on a nice, sunny day with the roof top of a car lowered and air blowing through. If it begins to rain, the driver pulls aside and ensures that the roof top is back up so no water gets inside. As soon as the rain passes, the top is down again. It is a benefit to the convertible car owner because his car can convert back and forth between having a roof and leaving it open. Sadly, __convertible preference shares__ do not work that way. Convertible preference shares are a type of preference share issued by a company. They allow for fixed-payment dividends as they behave like bond interest payments but represent a part of equity on a balance sheet. These convertibles, unlike other types of preference shares, may be converted to common shares after a preset date. However, the investor travels down a one-way street. Unlike convertible cars, convertible preference shares can only be converted to common stock once. They cannot be converted back.

When the convertible preference share's value reduces to $4.40 per share, with 1 share converting into 20 no par value common shares

When the common stock price reaches $75 per share

When the common stock's value is greater than $4.40, with 1 share converting into 20 no par value common shares

Once Grand converts to common shares, their order of liquidation payment priority is reduced

With Kol performing better than forecast, management does not wish to have additional voting influences

If Grand converts its shares to common shares, Kol's earnings per share will be diluted

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