CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
51. 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.)
a.
b.
c.
d.
e.
20-2 Leasing
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
52. 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.)
a.
$2,852
b.
$2,994
c.
$3,144
at I(1 − T)
at I(1 − T)
CHALLENGING
20-2 Leasing
False
JFND-GO4R-ER3U-1C4N
4OTI-GO4W-NQNBEE
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
d.
$3,301
e.
$3,466
a
Depreciation
Maintenance
CHALLENGING
20-2 Leasing
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
53. Emerson Electrical Engineering Inc. is issuing new 20-year bonds that have warrants attached. If not for the attached
warrants, the bonds would carry an 11% interest rate. However, with the warrants attached the bonds will pay a 9% annual
coupon. There are 25 warrants attached to each bond, which have a par value of $1,000. The exercise price of the warrants
is $25.00 and the expected stock price 10 years from now (when the warrants may be exercised) is $50.77. What is the
investor’s expected overall pre-tax rate of return for this bond-with-warrants issue?
a.
10.64%
b.
11.20%
c.
11.79%
d.
12.38%
e.
13.00%
c
Bond par value
$1,000
Conversion ratio (shares)
25
Bond maturity
20
Coupon rate
9.0%
Straight-debt yield
11.0%
Exercise price
$25.00
Total value gained in Year 10
644.25
11.79%
CHALLENGING
20-3 Warrants
QUESTION TYPE:
Multiple Choice
HAS VARIABLES:
False
LEARNING OBJECTIVES:
FOFM.BRIG.16.20.03 – Warrants
NATIONAL STANDARDS:
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
STATE STANDARDS:
United States – OH – DISC.FOFM.BRIG.16.08 – Investments
QUESTION ID:
JFND-GO4R-ER3U-1C4B
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
54. 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%?
a.
$790.48
b.
$830.01
c.
$871.51
d.
$915.08
e.
$960.84
a
$1,000
N
$30.00
CHALLENGING
20-4 Convertibles
False
JFND-GO4R-ER3U-1C33
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
55. 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
N
$80.00
CHALLENGING
20-4 Convertibles
False
JFND-GO4R-ER3U-1CTW
JFND-GO4R-ER3U-1CTI
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
56. 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?
a.
10.36%
b.
10.91%
c.
11.48%
d.
12.06%
e.
12.66%
c
Maturity
10.00%
11.48%
CHALLENGING
20-4 Convertibles
False
JFND-GO4R-ER3U-1C3A
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
57. Refer to Exhibit 20.1. What is the bond’s conversion ratio?
a.
27.14
b.
28.57
c.
30.00
d.
31.50
e.
33.08
$30.00
EASY
20-4 Convertibles
False
JFND-GO4R-ER3U-1C4G
G7TN-4CBS-GBTU-GATS–CIDI-GWN8-EPRW-EMJS-8Y4G-CC5D-8F1U-CA5D-CRSS–
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
58. Refer to Exhibit 20.1. What is the bond’s initial conversion value when issued?
a.
$698.15
b.
$734.89
c.
$773.57
d.
$814.29
e.
$857.14
e
EASY
20-4 Convertibles
False
JFND-GO4R-ER3U-1C4F
GCID-fc5aab749682-d11b-94a4-b162-4a110184
59. Refer to Exhibit 20.1. What is the bond’s straight-debt value at the time of issue?
a.
$684.78
b.
$720.82
c.
$758.76
d.
$798.70
e.
$838.63
GCID-fc5aab749682-d11b-94a4-b162-4a110184
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
MODERATE
20-4 Convertibles
False
JFND-GO4R-ER3U-1C4R
GCID-fc5aab749682-d11b-94a4-b162-4a110184
60. Refer to Exhibit 20.1. What is the minimum price (or “floor” price) at which the Saunders’ bonds should sell?
a.
$698.15
b.
$734.89
c.
$773.57
d.
$814.29
e.
$857.14
e
$857.14
$798.70
MODERATE
20-4 Convertibles
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES