United Technology Corporation (UTC) has $40 million of convertible bonds outstanding (40,000 bonds at $1,000 par value) with a coupon rate of 11 percent. Interest rates are currently 8 percent for bond of equal risk. The bonds have 15 years left to maturity. The bonds may be called at a 9 percent premium over par. They are convertible into 30 shares of common stock. The tax rate for the company is 25 percent.
The firm's common stock is currently selling for $41 and it pays a dividend of $3.50 per share. The expected income for the company is $38 million with 6 million shares outstanding.
Thoroughly analyze the bond and determine whether the firm should call the bond at the 9 percent call premium. In your analysis, consider the following:
a. The impact of the call on base and diluted earnings per share (assume the call forces conversion).
b. The consequences of your decision on financing flexibility.
c. The net change in cash outflows to the company as a result of the call and conversion.