Question 1

The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock.

Accepted Answer

A) True 
 B)False

Question 2

A lease-versus-purchase analysis should compare the cost of leasing to the cost of owning, assuming that the asset purchased

Accepted Answer

A)  is financed with short-term debt. 
B)  is financed with long-term debt. 
C)  is financed with debt whose maturity matches the term of the lease. 
D)  is financed with a mix of debt and equity based on the firm's target capital structure, i.e., at the WACC. 
E)  is financed with retained earnings. 
A)  is financed with short-term debt. 
B)  is financed with long-term debt. 
C)  is financed with debt whose maturity matches the term of the lease. 
D)  is financed with a mix of debt and equity based on the firm's target capital structure, i.e., at the WACC. 
E)  is financed with retained earnings.

Question 3

The owner of a convertible bond owns, in effect, both a bond and a call option.

Accepted Answer

A) True 
 B)False

Question 4

Ellis Enterprises is considering whether to lease or buy some necessary equipment it needs for a project that will last the next 3 years. If the firm buys the equipment, it will borrow $4,800,000 at 8% interest. The firm's tax rate is 35% and the firm's before-tax cost of debt is 8%. Annual maintenance costs associated with ownership are estimated to be $300,000 and the equipment will be depreciated on a straight-line basis over 3 years. What is the annual end-of-year lease payment (in thousands of dollars) for a 3-year lease that would make the firm indifferent between buying or leasing the equipment? (Suggestion: Delete 3 zeros from dollars and work in thousands.)

Accepted Answer

A)  $1,950 
B)  $2,052 
C)  $2,160 
D)  $2,268 
E)  $2,382 
A)  $1,950 
B)  $2,052 
C)  $2,160 
D)  $2,268 
E)  $2,382

Question 5

Preferred stockholders have priority over common stockholders with respect to dividends, because dividends must be paid on preferred stock before they can be paid on common stock. However, preferred and common stockholders normally have equal priority with respect to liquidating proceeds in the event of bankruptcy.

Accepted Answer

A) True 
 B)False

Question 6

Which of the following statements is most CORRECT?

Accepted Answer

A)  Warrants have an option feature but convertibles do not. 
B)  One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds. 
C)  The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt. 
D)  The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant. 
E)  Warrants can sometimes be detached and traded separately from the security with which they were issued, but this is unusual. 
A)  Warrants have an option feature but convertibles do not. 
B)  One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds. 
C)  The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt. 
D)  The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant. 
E)  Warrants can sometimes be detached and traded separately from the security with which they were issued, but this is unusual.

Question 7

Cannon Manufacturing is considering issuing 15-year, 8% annual 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 yield of 10%. The stock's current price is $25.00, its expected dividend is $2.50, and its expected growth rate is 5%. The bonds are noncallable for 10 years. What is the bond's conversion value in Year 5?

Accepted Answer

A)  $719.90 
B)  $757.79 
C)  $797.68 
D)  $837.56 
E)  $879.44 
A)  $719.90 
B)  $757.79 
C)  $797.68 
D)  $837.56 
E)  $879.44

Question 8

Herbert Engineering is issuing new 15-year bonds that have warrants attached. If not for the attached warrants, the bonds would carry a 9% annual interest rate. However, with the warrants attached the bonds will pay a 6% annual coupon. There are 30 warrants attached to each bond, which has a par value of $1,000. What is the value of the straight-debt portion of the bonds?

Accepted Answer

A)  $720.27 
B)  $758.18 
C)  $796.09 
D)  $835.89 
E)  $877.69 
A)  $720.27 
B)  $758.18 
C)  $796.09 
D)  $835.89 
E)  $877.69

Question 9

Which of the following statements about convertibles is most CORRECT?

Accepted Answer

A)  The coupon interest rate on a firm's convertibles is generally set higher than the market yield on its otherwise similar straight debt. 
B)  One advantage of convertibles over warrants is that the issuer receives additional cash money when convertibles are converted. 
C)  Investors are willing to accept a lower interest rate on a convertible than on otherwise similar straight debt because convertibles are less risky than straight debt. 
D)  At the time it is issued, a convertible's conversion (or exercise) price is generally set equal to or below the underlying stock's price. 
E)  For equilibrium to exist, the expected return on a convertible bond must normally be between the expected return on the firm's otherwise similar straight debt and the expected return on its common stock. 
A)  The coupon interest rate on a firm's convertibles is generally set higher than the market yield on its otherwise similar straight debt. 
B)  One advantage of convertibles over warrants is that the issuer receives additional cash money when convertibles are converted. 
C)  Investors are willing to accept a lower interest rate on a convertible than on otherwise similar straight debt because convertibles are less risky than straight debt. 
D)  At the time it is issued, a convertible's conversion (or exercise) price is generally set equal to or below the underlying stock's price. 
E)  For equilibrium to exist, the expected return on a convertible bond must normally be between the expected return on the firm's otherwise similar straight debt and the expected return on its common stock.

Question 10

Preferred stock normally has no voting rights. However, most preferred issues stipulate that the preferred stockholders can elect a minority number of the directors if the preferred dividend is omitted.

Accepted Answer

A) True 
 B)False

Question 11

Heavy use of off-balance-sheet lease financing will tend to

Accepted Answer

A)  make a company appear more risky than it actually is because its stated debt ratio will be increased. 
B)  make a company appear less risky than it actually is because its stated debt ratio will appear lower. 
C)  affect a company's cash flows but not its degree of risk. 
D)  have no effect on either cash flows or risk because the cash flows are already reflected in the income statement. 
E)  affect the lessee's cash flows but only due to tax effects. 
A)  make a company appear more risky than it actually is because its stated debt ratio will be increased. 
B)  make a company appear less risky than it actually is because its stated debt ratio will appear lower. 
C)  affect a company's cash flows but not its degree of risk. 
D)  have no effect on either cash flows or risk because the cash flows are already reflected in the income statement. 
E)  affect the lessee's cash flows but only due to tax effects.

Question 12

Curry Corporation is setting the terms on a new issue of bonds with warrants. The bonds will have a 30-year maturity and annual interest payments. Each bond will come with 20 warrants that give the holder the right to purchase one share of stock per warrant. The investment bankers estimate that each warrant will have a value of $10.00. A similar straight-debt issue would require a 10% coupon. What coupon rate should be set on the bonds-with-warrants so that the package would sell for $1,000?

Accepted Answer

A)  6.75% 
B)  7.11% 
C)  7.48% 
D)  7.88% 
E)  8.27% 
A)  6.75% 
B)  7.11% 
C)  7.48% 
D)  7.88% 
E)  8.27%

Question 13

Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price, and they also benefit from the 70% tax exemption on preferred dividends received.

Accepted Answer

A) True 
 B)False

Question 14

Operating leases help to shift the risk of obsolescence from the user to the lessor.

Accepted Answer

A) True 
 B)False

Question 15

Carolina Trucking Company (CTC) is evaluating a potential lease for a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 9%, and the loan would be amortized over the truck's 4-year life. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $12,000. If CTC buys the truck, it would purchase a maintenance contract that costs $1,500 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year. CTC's tax rate is 35%. What is the net advantage to leasing? (Note: MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.)

Accepted Answer

A)  $609 
B)  $642 
C)  $678 
D)  $715 
E)  $751 
A)  $609 
B)  $642 
C)  $678 
D)  $715 
E)  $751

Question 16

FAS 13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the

Accepted Answer

A)  residual value as a fixed asset. 
B)  residual value as a liability. 
C)  present value of future lease payments as an asset and also showing this same amount as an offsetting liability. 
D)  undiscounted sum of future lease payments as an asset and as an offsetting liability. 
E)  undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability. 
A)  residual value as a fixed asset. 
B)  residual value as a liability. 
C)  present value of future lease payments as an asset and also showing this same amount as an offsetting liability. 
D)  undiscounted sum of future lease payments as an asset and as an offsetting liability. 
E)  undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability.

Question 17

The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants are used.

Accepted Answer

A) True 
 B)False

Question 18

The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under IRS guidelines.

Accepted Answer

A) True 
 B)False

Question 19

Valdes Enterprises is considering issuing a 10-year convertible bond that would be priced at its $1,000 par value. The bonds would have an 8.00% annual coupon, and each bond could be converted into 20 shares of common stock. The required rate of return on an otherwise similar nonconvertible bond is 10.00%. The stock currently sells for $40.00 a share, has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 5.00%. What is the estimated floor price of the convertible at the end of Year 4?

Accepted Answer

A)  $901.28 
B)  $924.39 
C)  $948.09 
D)  $972.41 
E)  $996.72 
A)  $901.28 
B)  $924.39 
C)  $948.09 
D)  $972.41 
E)  $996.72

Question 20

From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's

Accepted Answer

A)  equity cash flows. 
B)  capital budgeting project cash flows. 
C)  debt cash flows. 
D)  pension fund cash flows. 
E)  sales. 
A)  equity cash flows. 
B)  capital budgeting project cash flows. 
C)  debt cash flows. 
D)  pension fund cash flows. 
E)  sales.

The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock.

A lease-versus-purchase analysis should compare the cost of leasing to the cost of owning, assuming that the asset purchased

The owner of a convertible bond owns, in effect, both a bond and a call option.

Which of the following statements is most CORRECT?

Which of the following statements about convertibles is most CORRECT?

Preferred stock normally has no voting rights. However, most preferred issues stipulate that the preferred stockholders can elect a minority number of the directors if the preferred dividend is omitted.

Heavy use of off-balance-sheet lease financing will tend to

Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price, and they also benefit from the 70% tax exemption on preferred dividends received.

Operating leases help to shift the risk of obsolescence from the user to the lessor.

FAS 13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the

The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants are used.

The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under IRS guidelines.

From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's

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

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Filters

Exam 20: Hybrid Financing

The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock.

A lease-versus-purchase analysis should compare the cost of leasing to the cost of owning, assuming that the asset purchased

The owner of a convertible bond owns, in effect, both a bond and a call option.

Which of the following statements is most CORRECT?

Which of the following statements about convertibles is most CORRECT?

Preferred stock normally has no voting rights. However, most preferred issues stipulate that the preferred stockholders can elect a minority number of the directors if the preferred dividend is omitted.

Heavy use of off-balance-sheet lease financing will tend to

Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price, and they also benefit from the 70% tax exemption on preferred dividends received.

Operating leases help to shift the risk of obsolescence from the user to the lessor.

FAS 13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the

The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants are used.

The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under IRS guidelines.

From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's

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