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ACCA Strategic Professional · Advanced Financial Management · Financing acquisitions and mergers

Gresham plc is considering financing an acquisition with a convertible bond rather than a straight bond. Which of the following is most likely to be a disadvantage of using the convertible to Gresham?

A key disadvantage is that conversion happens only if the share price exceeds the conversion price. If it does not, holders redeem for cash, so the company still has debt to repay and may face refinancing difficulty instead of the expected equity.

  1. AConversion raises equity automatically only if the share price is above the conversion price, so Gresham may be left with debt it must redeemCorrect
  2. BThe coupon is always higher than on straight debt
  3. CInterest on convertibles is never tax deductible
  4. DConvertibles can only be issued to existing shareholders

Explanation

If the share price stays below the conversion price, holders will redeem for cash, so the intended equity conversion fails and Gresham must refinance the principal. Convertibles usually carry a lower coupon, interest is generally tax deductible, and they are not limited to existing shareholders.

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