Volkswagen is an automobile manufacturing company that is based in California. The organization sells automobile engines to other automobile manufacturing companies and also sells complete automobile products mainly in Europe and Latin America. Volkswagen seeks to issue a convertible bond with the aim of increasing its production line to meet the growing automobile demand in Africa and Asia which are the emerging automobile markets. Volkswagen seeks to raise 2000 dollars for the planned expansion into the emerging automobile markets in Africa and Asia. 1000 dollars of this required capital will be raised through a convertible bond that is convertible to Volkswagen Inc. common stock.
Reason for issue a convertible bond
The primary reason for using a convertible preferred stock bond by Volkswagen. Inc. is due to the low interest that is accrued by using this method to raise capital. The organization requires huge operating capital, in this case, a convertible bond is payable in fixed amount of income, but the principal is retained until the bond matures. A preferred stock bond gives the organization the ability to retain enough operating capital, unlike other credit options. Also, a convertible bond can be issued to different interested investors who make it difficult for creditors to control the organization (Jiao & Yan, 2015).
Problems encountered in issuing a convertible bond
- Issuing a convertible bond is risky to an organization in cases when a single person purchases a bond. In this case, it was a challenge for the organization to ensure that the bond was not issued to a single investor.
- Volkswagen was faced with a dilemma in choosing the option of a preferred stock bond due to the risk of the investor converting the bond by force when the price of the stock rise to benefit themselves.
- The organization was at a risk of reducing the worth of the organization through offering a convertible bond because it has a tendency of diluting the company earnings per share which reduce the profitability of the shareholders in the short run.
Marketing a convertible bond
Investment bankers market a convertible bond using its safety and convertible option. A convertible bond is more safe to the investors willing to invest in an organization due to the minimum guaranteed return which ensures incase an organization becomes bankrupt the investors are paid fast. Besides, the interest earned by the convertible bond is exempted from taxes which makes a convertible bond more preferable by many investors. The bond was bought by financial institutions which wanted an investment opportunity with a minimum guaranteed return (Brown et al. 2013).
Volkswagen Inc. and Investor consideration
Amongst the key considerations were the maturity period for the bond and the interest payable annually that accompanied the loan. The firm was more interested in getting lower interest while the investor was keen on predicting the future stock price appreciation of the organization which could benefit the organization (Arcot, 2014).
Terms of the convertible bond and recommendation
The 1000 dollars par value is convertible to the organization common stock; the convertible bond has a coupon of 4% which is payable annually. The bond will mature in 10 years, and it is convertible with a convertible ratio of 100 shares of Volkswagen Inc. shares. At the end of the 9th, year after the bond is issued the investors are entitled to 1000 dollars principal and 40 dollars in interest payment if the investor does not convert the bond into stock. Now 100 shares are worth;
1100$(100share11 price per share). This figure surpasses the original value of the bond in which the investor is most likely to convert the bond into equity which will earn the investor 100 shares of the company. With the appreciating stock price of the Volkswagen Company, it is advisable for the investor to buy the convertible bond because there is the likelihood of the appreciation of the stock price.
Arcot, S. (2014). Participating convertible preferred stock in venture capital exits. Journal of Business Venturing, 29(1), 72-87.
Brown, S., Grundy, B. D., Lewis, C. M., & Verwijmeren, P. (2013). Hedge fund involvement in convertible securities. Journal of Applied Corporate Finance, 25(4), 60-73.
Jiao, J., & Yan, A. (2015). Convertible Securities And Heterogeneity Of Investor Beliefs. Journal of Financial Research, 38(2), 255-282.
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