Question

please I need this, step by step with formulas, avoid using excel.

CASE 33 Security Software, Inc. communication in a highly secure and efficient process. The Market Security Software, Inc. (SSI) was a major provider of application software. The firm was proud to be the number two company in the enterprise firewall market. Firewalls ensure network Security for businesses by determining whether to approve or deny access to corporate networks and applications. They have security software that inspects com- munication from the packet and network layer up to the application layer. SSI's firewall provides integrated access control, authentication, network address translation, content security, auditing, and enterprise policy management solutions. It is based on SSI's Stateful Inspection Technology, which enables the screening of all In June of 2016, Justin Harper, CEO of SSI, knew the firm would need to go to the financial markets in the next two months to raise new capital. The conversations with his investment banking firm, Southwest Securities, had not been very productive. Carol Travis, a senior vice president of the investment banking firm, had indicated that the market was extremely weak for software providers, but Justin did not realize the extent of the weakness until he examined Figure 1.

Answer 1

Q.1 If $30 million of $1000 per value bond are issued @ 7.5% interest with a conversion ratio of 40, then

a) Annual Interest payment will be = $30 million X 7.5 / 100 = $2.25 million

b) Numbers of New Shares will be created on conversion = $30 million / $1000 X 40 shares = 1.20 Million shares in numbers

or 1,200,000 no of New shares to be issued.

Q.2 If Mr. Justin raised $30 Million at current stock price of $19.50, then New Number of shares to be issued

= $30,000,000 / $19.50 = 1,538,462 nos of New Shares.

Q.3 If shares are issued when stock price reaches $35, then no of New shares to be issued

= $30,000,000 / $35 = 857,143 nos of New Shares.

However, this will not be a realistic move, as stock price is continuously decreasing and during the current year it has reaches maximum low. Given the situation in the market and also as evident from the discussion with the Investment Banker of SSI, that there are very little chances that stock price will move up in near future. SSI needed fund on immediate basis to carry on with its R&D activity which is extremely essential to the survival of its business. Hence, it will be imprudent to wait for the stock price to reach $35 per share for raising funds.

Q.4 If bonds would have been issued @11% Interest, then annual interest payout would have been

= $30 million X 11 / 100 = $3.30 million

However, at 7.5% annual interest payout is $2.25 million

Hence, with issuance of Convertible bond at 7.5% instead of straight bond at 11%, SSI will be saving annual interest of

($3.30 million - $2.25 million) = $1.05 million

Q.5 If convertible bonds are issued and stock price goes to $35 per share, the price of bond in the market will also go up with the chances of capital gain on conversion. However, bondholders can not get the bonds converted immediately as there will be lock in period (also called maturity period) for the bondholders and option to convert the bond into shares of the company can only be exercised, only after maturity.

Q.6 Normally convertible bonds are issued with an option of either to convert them into common stock of the company on maturity or to encash them on maturity at per value and interest is paid annually at the coupon rate to the bond holders. Now, if the company wants to force the bondholders to convert the bond to common stock of the maturity, then the bond issue script should clearly mention that on maturity bonds will be converted to common stock of the company at the stated conversion rate, which is 40 common stock per $1,000 bond value and there is no option to encash the bonds at maturity. However, this may dilute to interest of the investors to buy the bonds of SSI.

Q.7 (a)

Earnings before interest and taxes $15,000,000

Interest :

- as given in table in the question $ 1,000,000

- interest on convertible bonds (as calculated in Q1 above) $ 2,250,000

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Earnings before taxes $11,750,000

Less : Taxes @ 30% $ 3,525,000

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Earnings after taxes $ 8,225,000

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Therefore, Basic Earnings per Share = Earnings after Taxes / No of Common stock

= $8,225,000 / 10,000,000 = $0.82

Q.7 (b) Diluted earnings per share = (Earnings after Tax + Convertible Interest after tax) / (No of common stock + New Stock issued)

= ($8,225,000 + ($2,250,000 X (1-0.3))) / (10,000,000 + 1,200,000)

= ($8,225,000 + $1,575,000 ) / 11,200,000

= $9,800,000 / 11,200,000

= $0.875

Q.8 Basic EPS takes net income after tax, subtracts preferred dividends, and then divides by the weighted average number of shares of common stock outstanding during the period in question.

Diluted EPS doesn't use the number of shares outstanding, instead using the number of possible shares outstanding. In Diluted EPS, net income after tax is adjusted back for preferred dividends and interest paid on convertible bonds. if Preferred Stock and convertible bonds are there, then after tax impact of preferred dividends and interest on convertible bonds are added back to net earnings after tax and then divides by possible no of shares outstanding, that is, common stock outstanding as on date plus common stock to be issued on conversion of Preferred Share and Convertible bonds.

The need for computing diluted earnings per share is a drawback to the convertibles. Mainly because, financing with convertible securities runs the risk of diluting not only the EPS of the company's common stock but also the control of the company. If a large part of the issue is purchased by one buyer, typically an investment banker or insurance company, a conversion may shift the voting control of the company away from its original owners and toward the converters.

This potential is not a significant problem for large companies with millions of stockholders, but it is a very real consideration for smaller companies or those that have just gone public.