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Exam 20: Hybrid Financing

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Question 21

Multiple Choice

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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?

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

F) A) and D)
G) None of the above

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Question 22

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?

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

F) C) and D)
G) B) and C)

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Question 23

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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.

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.

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?

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.)

Which of the following is most CORRECT?

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

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.

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

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?

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

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?

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

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.

The following data apply to Saunders Corporation's convertible bonds. What is the bond's conversion ratio?

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

Which of the following statements concerning warrants is most CORRECT?

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.

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.)