High Flyers Inc. Suggested Solution
Risks
The primary risk is the ability to satisfy the ongoing cash flow requirements. For the
straight bonds, semi-annual interest payments must be made, and for the convertible
preferred shares, quarterly dividend payments must be made. Note that these dividends
are not entirely discretionary as are those on the common shares since the dividends on
the preferred shares are cumulative.
There will also be an obligation to repay the principal amount of the bonds upon
maturity or to refinance the bonds. A large payment like this could impair operating
capability. Similarly, if the price of the common shares does not rise as expected to
encourage conversion, the company will be left with relatively high-priced preferred
shares.
The underwriter (as opposed to an agent) will also be taking on the risk of selling these
securities. The complexity or the level of the call price for the preferred shares could
make the convertible preferred shares unattractive to potential investors. The saleability
of common shares would be affected by the expected performance and growth
prospects of the company, while the saleability of the straight bonds would be affected
by market interest rates and the credit rating of the company.
The risk of not beginning to produce positive cash flows is discussed under future
financing possibilities.
Operational Flexibility
The documents creating the straight bonds and convertible preferred shares will contain
financial ratio requirements and restrictions on executive compensation and loans to
shareholders. These constraints could impede operations requiring expenditures, as
well as the ability of the management shareholders to obtain the financial rewards of
their labour. In contrast, the constraints on the issuance of common shares are very
limited.
Although dividends are discretionary, the dividends on the convertible preferred shares
are cumulative and, thus, must eventually be...