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.

To analyze whether United Technology Corporation (UTC) should call the bond at the 9 percent call premium, we need to consider several factors. Let's break down each part of the analysis:

a. Impact on earnings per share (EPS):
First, let's calculate the current EPS for the company. Currently, they have an expected income of $38 million and 6 million shares outstanding. So, the current EPS is $38 million / 6 million = $6.33 per share.

If the bonds are called and forced to convert, we need to calculate the potential new EPS. Since each bond is convertible into 30 shares of common stock, there are a total of 40,000 * 30 = 1,200,000 additional shares that may be issued due to the conversion.

To calculate the potential new EPS after the conversion, we need to add the additional shares to the current outstanding shares. So, the total shares outstanding would be 6 million + 1.2 million = 7.2 million shares.

Now, we need to consider the impact of the call premium on the earnings. The call premium is 9 percent over par, which is 9 percent * $1,000 = $90 premium per bond.

The coupon rate on the convertible bonds is 11 percent, but the current interest rates are 8 percent. This means that if the bonds are not called, UTC would continue paying the higher coupon rate of 11 percent. By calling the bonds, UTC can reduce their interest expense and potentially increase their earnings.

So, the impact on EPS from the call and conversion would be:

Impact on EPS = (Additional interest expense avoided - Additional dividend payments due to new shares) / New shares outstanding

Additional interest expense avoided = 40,000 bonds * ($1,000 * 11%) * (11% - 8%)
Additional dividend payments due to new shares = 1,200,000 new shares * $3.50 per share
New shares outstanding = 7.2 million shares

Calculate the values above and plug them into the formula to determine the impact on EPS.

b. Consequences on financing flexibility:
Calling the bonds would reduce the debt on UTC's balance sheet, which would improve their financial flexibility. It would decrease their interest obligations and potentially improve their credit rating. This could make it easier and cheaper for UTC to raise funds in the future if they need to invest in new projects or finance growth opportunities.

c. Net change in cash outflows:
To calculate the net change in cash outflows, we need to consider the cash inflows from the conversion and the cash outflows from the call premium.

The cash inflows from the conversion can be calculated as the number of converted shares (1,200,000) multiplied by the current stock price ($41 per share). This will give you the cash inflow from the conversion.

The cash outflow from the call premium can be calculated as the number of bonds (40,000) multiplied by the call premium ($90 per bond) plus the tax savings from the interest expense reduction due to the call.

Calculate these values and compare the net cash inflows from the conversion to the net cash outflows from the call premium to determine the net change in cash outflows.

By thoroughly analyzing these factors, including the impact on EPS, the consequences on financing flexibility, and the net change in cash outflows, you will be able to determine whether UTC should call the bond at the 9 percent call premium.