Exam 20: Hybrid Financing: Preferred Stock,leasing,warrants,and Convertibles

Emerson Electrical Engineering Inc.is issuing new 20-year bonds that have warrants attached.If not for the attached warrants,the bonds would carry a 12.0% interest rate.However,with the warrants attached the bonds will pay a 10.0% annual coupon.There are 22 warrants attached to each bond,which have a par value of $1,000.The exercise price of the warrants is $23.00,and the expected stock price 10 years from now (when the warrants may be exercised)is $47.87.What is the investor's expected overall pre-tax rate of return for this bond-with-warrants issue? Do not round your intermediate calculations.

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

Chocolate Factory's convertible debentures were issued at their $1,000.00 par value in 2018.At any time prior to maturity on February 1,2038,a debenture holder can exchange a bond for 21 shares of common stock.What is the conversion price of the common stock,P_c? Do not round your intermediate calculations.

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 $5,400,000,the purchase price,at 9.6% and buy the tools,or it can make 3 equal end-of-year lease payments of $1,900,000 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 were leased.What is the net advantage to leasing (NAL),in thousands? (Suggestion: Delete 3 zeros from dollars and work in thousands. )Do not round your intermediate calculations.

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

Unlike with 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.

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

Thomson Engineering is issuing new 19-year bonds that have warrants attached.If not for the attached warrants,the bonds would carry a 12.3% annual interest rate.However,with the warrants attached the bonds will pay an 8.2% 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? Do not round your intermediate calculations.

Leasing is typically a financing decision rather than 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.

Warren Corporation's stock sells for $38.00 per share.The company wants to sell some 20-year,annual interest,$1,000 par value bonds.Each bond would have 85 warrants attached to it,each exercisable into one share of stock at an exercise price of $50.00.The firm's straight bonds yield 11.6%.Each warrant is expected to have a market value of $1.80 given that the stock sells for $38.00.What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par? Do not round your intermediate calculations.

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

Herbert Engineering is issuing new 22-year bonds that have warrants attached.If not for the attached warrants,the bonds would carry a 10.3% annual interest rate.However,with the warrants attached the bonds will pay a 6.3% 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? Do not round your intermediate calculations.

Historically,leasing was often referred to as off-balance-sheet financing because lease payments were shown as operating expenses on a firm's income statement,and leased assets and associated liabilities did not appear on the firm's balance sheet under certain conditions.

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

Which of the following statements is CORRECT?

Ballentine Inc. ,which has a zero tax rate due to tax loss carry-forwards,is considering a 6-year,$5,200,000 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 8.5%.Alternatively,Ballentine can also lease the equipment for an end-of-year payment of $1,220,000.By how much does the lease payment exceed the loan payment? Do not round your intermediate calculations.

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.

Quaid Co.'s common stock sells for $34.00,pays a dividend of $2.30,and has an expected long-term growth rate of 5.8%.The firm's straight-debt bonds yield an 11.20% return.Quaid is planning a convertible bond issue.The bonds will have a 20-year maturity,pay a 10.20% 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? Do not round your intermediate calculations.

The sale of call options cannot give rise to the problem of dilution of stockholders' earnings,but the use of warrants can.

Upstate Water Company just sold a bond with 57 warrants attached.The bonds have a 20-year maturity and an annual coupon of 11.4%,and they were issued at their $1,000 par value.The current yield on similar straight bonds is 17%.What is the implied value of each warrant? Do not round your intermediate calculations.