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Exam 20: Hybrid Financing

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Question 31

Multiple Choice

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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?

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

F) A) and E)
G) D) and E)

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Question 32

Multiple Choice

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

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.

F) D) and E)
G) A) and D)

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Question 33

Multiple Choice

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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?

Which of the following statements is most CORRECT?

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.)

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

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.

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.

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

Which of the following statements about convertibles is most CORRECT?

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.)

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?

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.

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

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?

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

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