Exam 20: Hybrid Financing

Bev's Beverages is negotiating a lease on a new piece of equipment that would cost $80,000 if purchased. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 3 years is $25,000. A maintenance contract on the equipment would cost $2,500 per year, payable at the beginning of each year. Alternatively, the firm could lease the equipment for 3 years for a lease payment of $23,000 per year, payable at the beginning of each year. The lease would include maintenance. The firm is in the 20% tax bracket, and it could obtain a 3-year simple interest loan, interest payable at the end of the year, to purchase the equipment at a before-tax cost of 8%. If there is a positive Net Advantage to Leasing the firm will lease the equipment. Otherwise, it will buy it. What is the NAL? (Note: MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.)

Based on your answers to the three preceding questions, what is the minimum price (or "floor" price) at which the Saunders' bonds should sell?

Chocolate Factory's convertible debentures were issued at their $1,000 par value in 2011. At any time prior to maturity on February 1, 2031, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?

Leasing is often referred to as off-balance-sheet financing because lease payments are shown as operating expenses on a firm's income statement and, under certain conditions, leased assets and associated liabilities do not appear on the firm's balance sheet.

Quaid Co.'s common stock sells for $28.00, pays a dividend of $2.10, and has an expected long-term growth rate of 6%. The firm's straight-debt bonds yield a 10.8% return. Quaid is planning a convertible bond issue. The bonds will have a 20-year maturity, pay a 10% annual coupon, have a par value of $1,000, and a conversion ratio of 25 shares per bond. The bonds will sell for $1,000 and will be callable after 10 years. Assuming that the bonds will be converted at Year 10, when they become callable, what will be the expected return on the convertible when it is issued?

Herring Inc. is considering issuing 15-year, 8% semiannual coupon, $1,000 face value convertible bonds at a price of $1,000 each. Each bond would be convertible into 25 shares of common stock. If the bonds were not convertible, investors would require an annual nominal yield of 10%. What is the straight-debt value of each bond at the time of issue?

Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.

Which of the following statements is most CORRECT?

Which of the following statements concerning warrants is most CORRECT?

Moniker Manufacturing's bonds were recently issued at their $1,000 par value. At any time prior to maturity (20 years from now), a bondholder can exchange a bond for a share of common stock at a conversion price of $40. What is the conversion ratio?

Sutton Corporation, which has a zero tax rate due to tax loss carry-forwards, is considering a 5-year, $6,000,000 bank loan to finance service equipment. The loan has an interest rate of 10% and would be amortized over 5 years, with 5 end-of-year payments. Sutton can also lease the equipment for 5 end-of-year payments of $1,790,000 each. How much larger or smaller is the bank loan payment than the lease payment? Note: Subtract the loan payment from the lease payment.

Operating leases often have terms that include

Atlas Anglers Inc. is considering issuing a 15-year convertible bond that will be priced at its $1,000 par value. The bonds have a 6.5% annual coupon rate, and each bond can be converted into 20 shares of common stock. The stock currently sells at $30 a share, has an expected dividend in the coming year of $3, and has an expected constant growth rate of 5.5%. What is the estimated floor price of the convertible at the end of Year 3 if the required rate of return on a similar straight-debt issue is 9.5%?

Upstate Water Company just sold a bond with 50 warrants attached. The bonds have a 20-year maturity and an annual coupon of 12%, and they were issued at their $1,000 par value. The current yield on similar straight bonds is 15%. What is the implied value of each warrant?

Kohers Inc. is considering a leasing arrangement to finance some manufacturing tools that it needs for the next 3 years. The tools will be obsolete and worthless after 3 years. The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life. It can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000 payable at the end of the year, but this cost would be borne by the lessor if the equipment is leased. What is the net advantage to leasing (NAL), in thousands? (Suggestion: Delete 3 zeros from dollars and work in thousands.)

The following data apply to Saunders Corporation's convertible bonds. What is the bond's conversion ratio? Maturity 10 Stock price $30.00 Par value $1,000 Conversion price $35.00 Annual coupon 5.00% Straight-debt yield 8.00%

Warren Corporation's stock sells for $42 per share. The company wants to sell some 20-year, annual interest, $1,000 par value bonds. Each bond would have 75 warrants attached to it, each exercisable into one share of stock at an exercise price of $47. The firm's straight bonds yield 10%. Each warrant is expected to have a market value of $2.00 given that the stock sells for $42. What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par?

What is the bond's straight-debt value at the time of issue?

Most convertible securities are bonds or preferred stocks that, under specified terms and conditions, can be exchanged for common stock at the option of the holder.

What is the bond's initial conversion value when issued?