Economics Chapter 20 The Investment Bankers Estimate That Each Warrant

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

37. Moniker Manufacturing’s bonds were recently issued at their $1,000 par value. At any time prior to maturity (20 years

from now), a bondholder can exchange a bond for a share of common stock at a conversion price of $40. What is the

conversion ratio?

a.

22.56

b.

23.75

c.

25.00

d.

26.25

e.

27.56

c

EASY

20-4 Convertibles

False

$1,000.00

25.00

EASY

20-4 Convertibles

False

JFND-GO4R-ER3U-1TBW

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

38. Its investment bankers have told Donner Corporation that it can issue a 25-year, 8.1% annual payment bond at par.

They also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in

the 40% tax bracket. The corporate investors require an after-tax return on the preferred that exceeds their after-tax return

on the bonds by 1.0%, which would represent an after-tax risk premium. What coupon rate must be set on the preferred in

order to issue it at par?

a.

6.66%

b.

6.99%

c.

7.34%

d.

7.71%

e.

8.09%

a

Maturity

8.10%

40.00%

1.00%

MODERATE

20-1 Preferred Stock

False

JFND-GO4R-ER3U-1CTA

JFND-GO4R-ER3U-1C1N

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

39. Sutton Corporation, which has a zero tax rate due to tax loss carry-forwards, is considering a 5-year, $6,000,000 bank

loan to finance service equipment. The loan has an interest rate of 10% and would be amortized over 5 years, with 5 end-

of-year payments. Sutton can also lease the equipment for 5 end-of-year payments of $1,790,000 each. How much larger

or smaller is the bank loan payment than the lease payment? Note: Subtract the loan payment from the lease payment.

a.

$177,169

b.

$196,854

c.

$207,215

d.

$217,576

e.

$228,455

c

Loan:

MODERATE

20-2 Leasing

False

JFND-GO4R-ER3U-1C1B

40. Ballentine Inc., which has a zero tax rate due to tax loss carry-forwards, is considering a 6-year, $5,000,000 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 9%. Alternatively, Ballentine can also lease the equipment for an end-of-year payment of $1,250,000. By

how much does the lease payment exceed the loan payment?

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

a.

$110,285

b.

$116,090

c.

$122,199

d.

$128,631

e.

$135,401

e

Loan:

1

MODERATE

20-2 Leasing

False

JFND-GO4R-ER3U-1CT3

GO4W-NQNBEE

41. 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.)

a.

$ 96

b.

$106

c.

$112

d.

$117

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

e.

$123

Tax rate

Loan amount = equipment cost

Maintenance costs

$240

Interest rate

Salvage value

Lease payment

After-tax cost of debt = Rate × (1 − T) =

Annual depreciation = Cost/Yrs. =

Tax savings from deprec. = Deprec. × T =

Purchase analysis:

Maintenance cost

Maint. tax savings = Maint × T

Deprec. tax savings

Leasing analysis:

Lease payment

Tax savings from lease

20-2 Leasing

Multiple Choice

FOFM.BRIG.16.20.02 – Leasing

United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills

United States – OH – DISC.FOFM.BRIG.16.08 – Investments

Multiple Choice: Problem

4/17/2014 5:07 PM

11/14/2014 2:54 PM

42. Warren Corporation’s stock sells for $42 per share. The company wants to sell some 20-year, annual interest, $1,000

par value bonds. Each bond would have 75 warrants attached to it, each exercisable into one share of stock at an exercise

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

price of $47. The firm’s straight bonds yield 10%. Each warrant is expected to have a market value of $2.00 given that the

stock sells for $42. What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants

at par?

a.

7.83%

b.

8.24%

c.

8.65%

d.

9.08%

e.

9.54%

$42.00

$1,000

$47.00

$1,000

MODERATE

20-3 Warrants

False

JFND-GO4R-ER3U-1C1F

4OTI-GO4W-NQNBEE

43. 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?

a.

6.75%

b.

7.11%

c.

7.48%

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

d.

7.88%

e.

8.27%

$1,000

$10.00

10.0%

MODERATE

20-3 Warrants

False

JFND-GO4R-ER3U-1C1R

44. 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?

a.

$3.76

b.

$3.94

c.

$4.14

d.

$4.35

e.

$4.56

a

$1,000

12.0%

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

$1,000

$187.78

MODERATE

20-3 Warrants

False

JFND-GO4R-ER3U-1C1D

45. Curran Contracting is issuing new 25-year bonds that have warrants attached. If not for the attached warrants, the

bonds would carry an 11% annual interest rate. However, with the warrants attached the bonds will pay an 8% annual

coupon. There are 30 warrants attached to each bond, which have a par value of $1,000. What is the implied value of each

warrant?

a.

$8.00

b.

$8.42

c.

$8.84

d.

$9.28

e.

$9.75

$1,000

8.0%

$80

$1,000

$252.65

MODERATE

20-3 Warrants

False

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

46. 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

$1,000

$60

MODERATE

20-3 Warrants

False

G7TN-4CBS-GBTU-GATS–CIDI-GWN8-EPRW-EMJO-CW5U-K3MB-CW5D-K3JZ-

JFND-GO4R-ER3U-1CTU

GO4W-NQNBEE

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

47. Thomson Engineering is issuing new 20-year bonds that have warrants attached. If not for the attached warrants, the

bonds would carry an 11% annual interest rate. However, with the warrants attached the bonds will pay an 8% 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?

a.

$652.55

b.

$686.89

c.

$723.05

d.

$761.10

e.

$799.16

$1,000

8.0%

11.0%

$80

MODERATE

20-3 Warrants

False

JFND-GO4R-ER3U-1CTT

GO4W-NQNBEE

48. 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.

$725.58

b.

$763.76

c.

$803.96

d.

$846.28

e.

$888.59

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

49. 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?

a.

$719.90

b.

$757.79

c.

$797.68

d.

$837.56

e.

$879.44

c

$1,000

10.0%

MODERATE

20-4 Convertibles

$1,000

10.0%

I/YR

N

MODERATE

20-4 Convertibles

False

JFND-GO4R-ER3U-1CTO

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND

CONVERTIBLES

50. 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.)

a.

$1,950

b.

$2,052

c.

$2,160

d.

$2,268

e.

$2,382

c

Totals

0.3333

Depreciation

Maintenance

I/YR

5.20%

False

JFND-GO4R-ER3U-1CTZ