Question 1

A warrant is an option, and as such it cannot be used as a "sweetener."

Accepted Answer

A) True 
 B)False  False

Question 2

A detachable warrant is a warrant that can be removed from the security with which it was issued and traded separately from it. Most traded warrants are originally attached to bonds or preferred stocks.

Accepted Answer

A) True 
 B)False  True

Question 3

Curran Contracting is issuing new 25-year bonds that have warrants attached. If not for the attached warrants, the bonds would carry an 11% annual interest rate. However, with the warrants attached the bonds will pay an 8% annual coupon. There are 30 warrants attached to each bond, which have a par value of $1,000. What is the implied value of each warrant?

Accepted Answer

A)  $8.00 
B)  $8.42 
C)  $8.84 
D)  $9.28 
E)  $9.75 
A)  $8.00 
B)  $8.42 
C)  $8.84 
D)  $9.28 
E)  $9.75 B

Question 4

Leasing is typically a financing decision and not a capital budgeting decision. The decision to acquire the asset is a "done deal" before the lease analysis begins. Therefore, in a lease analysis, we are concerned simply with whether to finance the asset with a lease or with a loan.

Accepted Answer

A) True 
 B)False

Question 5

Firms generally do not call their convertibles unless the conversion value is greater than the call price.

Accepted Answer

A) True 
 B)False

Question 6

Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.

Accepted Answer

A) True 
 B)False

Question 7

Thomson Engineering is issuing new 20-year bonds that have warrants attached. If not for the attached warrants, the bonds would carry an 11% annual interest rate. However, with the warrants attached the bonds will pay an 8% annual coupon. There are 30 warrants attached to each bond, which have a par value of $1,000. What is the value of the straight-debt portion of the bonds?

Accepted Answer

A)  $652.55 
B)  $686.89 
C)  $723.05 
D)  $761.10 
E)  $799.16 
A)  $652.55 
B)  $686.89 
C)  $723.05 
D)  $761.10 
E)  $799.16

Question 8

Under a sale and leaseback arrangement, the seller of the leased property is the lessee and the buyer is the lessor.

Accepted Answer

A) True 
 B)False

Question 9

A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock.

Accepted Answer

A) True 
 B)False

Question 10

Its investment bankers have told Donner Corporation that it can issue a 25-year, 8.1% annual payment bond at par. They also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 40% tax bracket. The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 1.0%, which would represent an after-tax risk premium. What coupon rate must be set on the preferred in order to issue it at par?

Accepted Answer

A)  6.66% 
B)  6.99% 
C)  7.34% 
D)  7.71% 
E)  8.09% 
A)  6.66% 
B)  6.99% 
C)  7.34% 
D)  7.71% 
E)  8.09%

Question 11

Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.

Accepted Answer

A) True 
 B)False

Question 12

A sale and leaseback arrangement is a type of financial, or capital, lease.

Accepted Answer

A) True 
 B)False

Question 13

A convertible debenture can never sell for more than its conversion value or less than its bond value.

Accepted Answer

A) True 
 B)False

Question 14

If a leased asset has a negative residual value, for example, as a result of a statutory requirement to dispose of an asset in an environmentally sound manner, the lessee of the asset could reasonably expect to pay a lower lease rate because the asset does not have a positive residual value.

Accepted Answer

A) True 
 B)False

Question 15

Ballentine Inc., which has a zero tax rate due to tax loss carry-forwards, is considering a 6-year, $5,000,000 bank loan in order to buy a new piece of equipment. The loan will be amortized over 6 years with end-of-year payments and has an interest rate of 9%. Alternatively, Ballentine can also lease the equipment for an end-of-year payment of $1,250,000. By how much does the lease payment exceed the loan payment?

Accepted Answer

A)  $110,285 
B)  $116,090 
C)  $122,199 
D)  $128,631 
E)  $135,401 
A)  $110,285 
B)  $116,090 
C)  $122,199 
D)  $128,631 
E)  $135,401

Question 16

Which of the following is most CORRECT?

Accepted Answer

A)  Firms that use "off-balance-sheet" financing, such as leasing, would show lower debt ratios if the effects of their leases were reflected in their financial statements. 
B)  Capitalizing a lease means that the firm issues equity capital in proportion to its current capital structure, in an amount sufficient to support the lease payment obligation. 
C)  The fixed charges associated with a lease can be as high as, but never greater than, the fixed payments associated with a loan. 
D)  Capital, or financial, leases generally provide for maintenance by the lessor. 
E)  A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas with an operating lease the lessor depends on the residual value to realize a full return of and on the investment. 
A)  Firms that use "off-balance-sheet" financing, such as leasing, would show lower debt ratios if the effects of their leases were reflected in their financial statements. 
B)  Capitalizing a lease means that the firm issues equity capital in proportion to its current capital structure, in an amount sufficient to support the lease payment obligation. 
C)  The fixed charges associated with a lease can be as high as, but never greater than, the fixed payments associated with a loan. 
D)  Capital, or financial, leases generally provide for maintenance by the lessor. 
E)  A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas with an operating lease the lessor depends on the residual value to realize a full return of and on the investment.

Question 17

Assume that a piece of leased equipment has a relatively high expected residual value. From the lessee's viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate.

Accepted Answer

A) True 
 B)False

Question 18

Orient Airlines' common stock currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2022. What is the conversion value of the bond?

Accepted Answer

A)  $707.33 
B)  $744.56 
C)  $783.75 
D)  $825.00 
E)  $866.25 
A)  $707.33 
B)  $744.56 
C)  $783.75 
D)  $825.00 
E)  $866.25

Question 19

In the lease-versus-buy decision, leasing is often preferable

Accepted Answer

A)  because it has no effect on the firm's ability to borrow to make other investments. 
B)  because, generally, no down payment is required, and there are no indirect interest costs. 
C)  because lease obligations do not affect the firm's risk as seen by investors. 
D)  because the lessee owns the property at the end of the lease term. 
E)  because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset. 
A)  because it has no effect on the firm's ability to borrow to make other investments. 
B)  because, generally, no down payment is required, and there are no indirect interest costs. 
C)  because lease obligations do not affect the firm's risk as seen by investors. 
D)  because the lessee owns the property at the end of the lease term. 
E)  because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.

Question 20

Emerson Electrical Engineering Inc. is issuing new 20-year bonds that have warrants attached. If not for the attached warrants, the bonds would carry an 11% interest rate. However, with the warrants attached the bonds will pay a 9% annual coupon. There are 25 warrants attached to each bond, which have a par value of $1,000. The exercise price of the warrants is $25.00 and the expected stock price 10 years from now (when the warrants may be exercised) is $50.77. What is the investor's expected overall pre-tax rate of return for this bond-with-warrants issue?

Accepted Answer

A)  10.64% 
B)  11.20% 
C)  11.79% 
D)  12.38% 
E)  13.00% 
A)  10.64% 
B)  11.20% 
C)  11.79% 
D)  12.38% 
E)  13.00%

A warrant is an option, and as such it cannot be used as a "sweetener."

A detachable warrant is a warrant that can be removed from the security with which it was issued and traded separately from it. Most traded warrants are originally attached to bonds or preferred stocks.

Leasing is typically a financing decision and not a capital budgeting decision. The decision to acquire the asset is a "done deal" before the lease analysis begins. Therefore, in a lease analysis, we are concerned simply with whether to finance the asset with a lease or with a loan.

Firms generally do not call their convertibles unless the conversion value is greater than the call price.

Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.

Under a sale and leaseback arrangement, the seller of the leased property is the lessee and the buyer is the lessor.

A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock.

Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.

A sale and leaseback arrangement is a type of financial, or capital, lease.

A convertible debenture can never sell for more than its conversion value or less than its bond value.

If a leased asset has a negative residual value, for example, as a result of a statutory requirement to dispose of an asset in an environmentally sound manner, the lessee of the asset could reasonably expect to pay a lower lease rate because the asset does not have a positive residual value.

Which of the following is most CORRECT?

Assume that a piece of leased equipment has a relatively high expected residual value. From the lessee's viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate.

Orient Airlines' common stock currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2022. What is the conversion value of the bond?

In the lease-versus-buy decision, leasing is often preferable

Overview

Financial Markets

Financial Statements

Statement Analysis

Time Value of Money

Interest Rates

Bonds

Risk and Return

Stocks

Cost of Capital

Capital Budgeting

Cash Flow and Risk

Real Options

Capital Structure

Dividends

Working Capital

Forecasting

Derivatives

Multinational

Mergers

Filters

Exam 20: Hybrid Financing

A warrant is an option, and as such it cannot be used as a "sweetener."

A detachable warrant is a warrant that can be removed from the security with which it was issued and traded separately from it. Most traded warrants are originally attached to bonds or preferred stocks.

Leasing is typically a financing decision and not a capital budgeting decision. The decision to acquire the asset is a "done deal" before the lease analysis begins. Therefore, in a lease analysis, we are concerned simply with whether to finance the asset with a lease or with a loan.

Firms generally do not call their convertibles unless the conversion value is greater than the call price.

Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.

Under a sale and leaseback arrangement, the seller of the leased property is the lessee and the buyer is the lessor.

A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock.

Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.

A sale and leaseback arrangement is a type of financial, or capital, lease.

A convertible debenture can never sell for more than its conversion value or less than its bond value.

If a leased asset has a negative residual value, for example, as a result of a statutory requirement to dispose of an asset in an environmentally sound manner, the lessee of the asset could reasonably expect to pay a lower lease rate because the asset does not have a positive residual value.

Which of the following is most CORRECT?

Assume that a piece of leased equipment has a relatively high expected residual value. From the lessee's viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate.

Orient Airlines' common stock currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2022. What is the conversion value of the bond?

In the lease-versus-buy decision, leasing is often preferable

Overview

Financial Markets

Financial Statements

Statement Analysis

Time Value of Money

Interest Rates

Bonds

Risk and Return

Stocks

Cost of Capital

Capital Budgeting

Cash Flow and Risk

Real Options

Capital Structure

Dividends

Working Capital

Forecasting

Derivatives

Multinational

Mergers

Filters