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CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
1. The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will
common stock.
a.
True
b.
False
2. Unlike 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.
a.
True
b.
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
3. A sale and leaseback arrangement is a type of financial, or capital, lease.
a.
True
b.
False
4. Operating leases help to shift the risk of obsolescence from the user to the lessor.
a.
True
b.
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
5. Under a sale and leaseback arrangement, the seller of the leased property is the lessee and the buyer is the lessor.
a.
True
b.
False
6. The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under IRS
guidelines.
a.
True
b.
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
7. 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.
a.
True
b.
False
8. A warrant is an option, and as such it cannot be used as a "sweetener."
a.
True
b.
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
9. A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock.
a.
True
b.
False
10. The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants
are used.
a.
True
b.
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
11. A detachable warrant is a warrant that can be removed from the security with which it was issued and traded
separately from it. Most traded warrants are originally attached to bonds or preferred stocks.
a.
True
b.
False
12. The owner of a convertible bond owns, in effect, both a bond and a call option.
a.
True
b.
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
13. A convertible debenture can never sell for more than its conversion value or less than its bond value.
a.
True
b.
False
14. 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.
a.
True
b.
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
15. Firms generally do not call their convertibles unless the conversion value is greater than the call price.
a.
True
b.
False
16. 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.
a.
True
b.
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
17. 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.
a.
True
b.
False
18. 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.
a.
True
b.
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
19. Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot
issue either pure debt or common stock at any reasonable cost.
a.
True
b.
False
20. 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.
a.
True
b.
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
21. 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.
a.
True
b.
False
22. 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.
a.
True
b.
False
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
23. Assume that a piece of leased equipment has a relatively high expected residual value. From the lessee's viewpoint, it
might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher
lease rate.
a.
True
b.
False
24. From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
the same as the riskiness of the lessee's
a.
equity cash flows.
b.
capital budgeting project cash flows.
c.
debt cash flows.
d.
pension fund cash flows.
e.
sales.
25. Operating leases often have terms that include
a.
maintenance of the equipment by the lessor.
b.
full amortization over the life of the lease.
c.
very high penalties if the lease is cancelled.
d.
restrictions on how much the leased property can be used.
e.
much longer lease periods than for most financial leases.
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
26. Which of the following statements is most CORRECT?
a.
Preferred stock generally has a higher component cost of capital to the firm than does common stock.
b.
By law in most states, all preferred stock must be cumulative, meaning that the compounded total of all unpaid
preferred dividends must be paid before any dividends can be paid on the firm's common stock.
c.
From the issuer's point of view, preferred stock is less risky than bonds.
d.
Whereas common stock has an indefinite life, preferred stocks always have a specific maturity date, generally
25 years or less.
e.
Unlike bonds, preferred stock cannot have a convertible feature.
27. Which of the following is most CORRECT?
a.
Firms that use "off-balance-sheet" financing, such as leasing, would show lower debt ratios if the effects of
their leases were reflected in their financial statements.
b.
Capitalizing a lease means that the firm issues equity capital in proportion to its current capital structure, in an
amount sufficient to support the lease payment obligation.
c.
The fixed charges associated with a lease can be as high as, but never greater than, the fixed payments
associated with a loan.
d.
Capital, or financial, leases generally provide for maintenance by the lessor.
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
e.
A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments
provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas
with an operating lease the lessor depends on the residual value to realize a full return of and on the
investment.
28. FAS 13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet
by reporting the
a.
residual value as a fixed asset.
b.
residual value as a liability.
c.
present value of future lease payments as an asset and also showing this same amount as an offsetting liability.
d.
undiscounted sum of future lease payments as an asset and as an offsetting liability.
e.
undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability.
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
29. Heavy use of off-balance-sheet lease financing will tend to
a.
make a company appear more risky than it actually is because its stated debt ratio will be increased.
b.
make a company appear less risky than it actually is because its stated debt ratio will appear lower.
c.
affect a company's cash flows but not its degree of risk.
d.
have no effect on either cash flows or risk because the cash flows are already reflected in the income
statement.
e.
affect the lessee's cash flows but only due to tax effects.
30. In the lease-versus-buy decision, leasing is often preferable
a.
because it has no effect on the firm's ability to borrow to make other investments.
b.
because, generally, no down payment is required, and there are no indirect interest costs.
c.
because lease obligations do not affect the firm's risk as seen by investors.
d.
because the lessee owns the property at the end of the lease term.
e.
because the lessee may have greater flexibility in abandoning the project in which the leased property is used
than if the lessee bought and owned the asset.
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
31. 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.
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
32. Which of the following statements about convertibles is most CORRECT?
a.
The coupon interest rate on a firm's convertibles is generally set higher than the market yield on its otherwise
similar straight debt.
b.
One advantage of convertibles over warrants is that the issuer receives additional cash money when
convertibles are converted.
c.
Investors are willing to accept a lower interest rate on a convertible than on otherwise similar straight debt
because convertibles are less risky than straight debt.
d.
At the time it is issued, a convertible's conversion (or exercise) price is generally set equal to or below the
underlying stock's price.
e.
For equilibrium to exist, the expected return on a convertible bond must normally be between the expected
return on the firm's otherwise similar straight debt and the expected return on its common stock.
33. Which of the following statements concerning warrants is most CORRECT?
a.
Bonds with warrants and convertible bonds both have option features that their holders can exercise if the
underlying stock's price increases. However, if the option is exercised, the issuing company's debt declines if
warrants are used but remains the same if convertibles are used.
b.
Warrants are long-term put options that have value because holders can sell the firm's common stock at the
exercise price regardless of how low the market price drops.
c.
Warrants are long-term call options that have value because holders can buy the firm's common stock at the
exercise price regardless of how high the stock's price has risen.
d.
A firm's investors would generally prefer to see it issue bonds with warrants than straight bonds because the
warrants dilute the value of new shareholders, and that value is transferred to existing shareholders.
e.
A drawback to using warrants is that if the firm is very successful, investors will be less likely to exercise the
warrants, and this will deprive the firm of receiving any new capital.
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
34. Which of the following statements is most CORRECT?
a.
Warrants have an option feature but convertibles do not.
b.
One important difference between warrants and convertibles is that convertibles bring in additional funds
when they are converted, but exercising warrants does not bring in any additional funds.
c.
The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise
similar straight debt even though investing in convertibles is more risky than investing in straight debt.
d.
The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile
stock, other things held constant.
e.
Warrants can sometimes be detached and traded separately from the security with which they were issued, but
this is unusual.
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, LEASING, WARRANTS, AND
CONVERTIBLES
35. 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
36. Chocolate Factory's convertible debentures were issued at their $1,000 par value in 2011. At any time prior to maturity
on February 1, 2031, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion
price, Pc?
a.
$40.00
b.
$42.00
c.
$44.10
d.
$46.31
e.
$48.62
