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P17-5. Lease versus purchase
LG 2; Challenge
a. Lease
Purchase
Year
Loan
Payment
(1)
Main-
tenance
(2)
Depre-
ciation
(3)
Interest
at 14%
(4)
Total
Deductions
(2 3 4)
(5)
Tax Shields
[(0.40)
(5)]
(6)
After-Tax
Cash Outflows
[(1 2) (6)]
(7)
1 $23,302 $2,000 $16,000 $11,200 $29,200 $11,680 $13,622
b. Lease
End of Year
Lease After-Tax
Cash Outflows
Purchase After-Tax
Cash Outflows
1 $11,880 $13,622
c. The present value of the cash outflows is less with the purchasing plan, so the firm should purchase
P17-6. Personal finance problem: Lease-versus-purchase decision
LG 2; Intermediate
a. Total leasing costs
b. Purchase cost
P17-7. Capitalized lease values
LG 2; Intermediate
Lease Calculator Inputs Capitalized Value
AN 12, I 10%, PMT $40,000 $272,547.67
P17-8. Conversion price
LG 3; Basic
P17-9. Conversion ratio
LG 3; Basic
P17-10. Conversion (or stock) value
LG 3; Basic
a. Bond value 25 shares $50 $1,250
P17-11. Conversion (or stock) value
LG 3; Basic
Bond Conversion Value
A 25$42.25 $1,
P17-12. Straight bond values
LG 4; Intermediate
Bond Years Payments
Interest Rate on
Equal-Risk Straight
Bond
Straight
Bond Value
A 119 $ 100 14% $735.07
P17-13. Determining values—convertible bond
LG 4; Challenge
a.
Years Payments Discount Rate Straight Bond Value
1–19 $ 100 12% $850.61
b. Conversion value 50 sharesmarket price
c.
Share Price Expected
Bond Value
$15 $850.61
d. The minimum bond value is $850.61. The bond will not sell for less than the straight bond value but
P17-14. Determining values–convertible bond
LG 4; Challenge
a. Straight Bond Value
Years Payments Discount Rate Straight Bond Value
1–14 $ 130 16% $832.74
b. Conversion value
$9.00 80 $720
c.
Share Price Bond Value
$ 9.00 $ 832.74 (Bond will not sell below straight bond value)
d.
P17-15. Implied price of attached warrants
LG 5; Intermediate
Implied price of all warrants price of bond with warrants straight bond value
=implied price of all warrants
Price per warrant number of warrants
Straight bond value:
Bond Years Payments Discount Rate
Straight
Bond Values
A 1–14 $ 120 13% $935.38
15 1,120
Price per warrant:
Bond
Price with
Warrants
Straight
Bond Value
Implied
Price
Number
of Warrants
Price per
Warrant
A $1,000 – $935.38 $64.62 10 $6.46
P17-16. Evaluation of the implied price of an attached warrant
LG 5; Challenge
a. Straight bond value
Years Payments Discount Rate Straight Bond Value
b. Implied price of all warrants (price with warrants − straight bond value)
c. Price per warrant Implied price of all warrants number of warrants
d. The implied price of $11.24 is below the theoretical value of $12.50, which makes the bond an
P17-17. Warrant values
LG 5; Challenge
a. TVW (P0 E)N
b.
c. It tends to support the graph because the market value of the warrant for the $50 share price appears
d. The warrant premium results from a combination of investor expectations and the ability of the
e. Yes, the premium will decline to zero as the warrant expiration date approaches. This occurs due to
P17-18. Personal finance: Common stock versus warrant investment
LG 5; Challenge
a. $8,000 $50 per share 160 shares
P17-19. Personal finance: Common stock versus warrant investment
LG 5; Challenge
a. $6,300 $30 per share 210 shares purchased
b. $6,300 $7 per warrant 900 warrants purchased
P17-20. Option profits and losses
LG 6; Intermediate
Option
a. 100 shares$5/share$500
$500 $200 $300
P17-21. Personal finance: Call option
LG 6; Intermediate
a. Stock transaction:
b. Option transaction:
c. $600 100 shares $6/share
d. If Carol actually purchases the stock, she will need to invest $6,200 ($62/share100 shares) and
P17-22. Personal finance: Put option
LG 5; Intermediate
a. ($45 $46)100 shares $100
b. The option would not be exercised above the striking price.
c. If the price of the stock rises above the striking price, the risk is limited to the price of the put option.
P17-23. Ethics problem
LG 6; Challenge
As long as the portfolio manager making investments on behalf of the Harvard University endowment
Case
Case studies are available on www.myfinancelab.com.
Financing L. Rashid Company’s Chemical Waste Disposal System
In this case, the student is asked to evaluate three long-term financing alternatives for the company’s proposed
waste disposal system: straight debt, debt with warrants, or a financial lease. After determining the cost of each
option on a present value basis, the student must choose the best alternative for L. Rashid Company.
a. 1. Straight debt value:
2. Implied price of all warrants $3,000,000 $2,897,437 $102,563
3. Implied price of each warrant
$102,563 $2.05
50, 000
4. Theoretical value of warrant TVW (P0 E) N
b. The price is clearly too high because the lender is effectively paying $2.05 for a warrant that has an estimated
c. Debt with warrants is the best option due to the high implied price, lower payments (10% interest rate, versus
d. Purchase alternative, financed using debt with warrants:
1. Annual interest expense
End of
Year
Loan
Payment
(1)
Beginning
Principal
(2)
Interest Payments
[0.10(2)] (3)
Principal
[(1) (3)] (4)
Ending Principal
[(2) (4)] (5)
aSlight rounding error
2. After-tax cash outflows:
Year
Loan
Payment
(1)
Main-
tenance
(2)
Depre-
ciation*
(3)
Interest
(from
Part (1))
(4)
Total
Deductions
(2 3 4)
(5)
Tax
Shields
[(0.40) (5)]
(6)
After-Tax
Cash
Outflow
[(1 2) (6)]
(7)
*Depreciation:
3. Present value of cash outflows
End of Year
After-Tax
Cash Outflow Discount Rate
PV of Outflows
e. Lease alternative
1. Annual after-tax outflows:
2. Present value of cash outflows
End of Year
After-Tax
Cash Outflow
Discount
Rate
PV of
Outflows
f. Purchasing the waste disposal system using debt with warrant financing is the preferred alternative.
Spreadsheet Exercise
The answer to Chapter 17’s comparison of leasing versus purchasing spreadsheet problem is located on
the Instructor’s Resource Center at www.pearsonhighered.com/irc under the Instructor’s Manual.
Group Exercise
Group exercises are available on www.myfinancelab.com.
Special topics in financial management begin with this chapter’s look at hybrid and derivative securities.
