Solutions to Problems
P17-1. Lease cash flows
LG 2; Basic
Firm Year Lease Payment
(1) Tax Benefit
(2)
After-Tax Cash
Outflow
[(1) (2)]
(3)
A1–4 $100,000 $40,000 $60,000
B1–14 80,000 32,000 48,000
P17-2. Loan interest
LG 2; Intermediate
Loan Year Interest
Amount
A 1 $1,400
2 1,098
3 767
4 402
2 5,822
3 4,639
4 3,290
6 993
P17-3. Loan payments and interest
LG 2; IntermediateLG 2; Intermediate
N 6, I 14%, PV $117,000
Year Beginning
Balance Interest Principal
1 $117,000.00 $16,380.00 $
13,707.43
2 103,292.57 14,460.96 15,626.47
Note: Due to rounding the payment to cents, the actual amount paid exceeds the amount borrowed by
three cents. The amount paid in the final year is usually adjusted so that there is no balance at the end of
the loan.
P17-4. Lease versus purchase
LG 2; Challenge
a. Lease
option in year 5 (total $35,880).
Purchase
Year
Loan
Payme
nt
(1)
Main-
tenance
(2)
Depre-
ciation
(3)
Interest
at 14%
(4)
Total
Deductio
ns
(2 3
4)
(5)
Tax
Shields
[(0.40)
(5)]
(6)
After-Tax
Cash Outflows
[(1 2) (6)]
(7)
1 $23,3
02 $2,000 $16,00
0$11,20
0$29,20
0$11,6
80 $13,622
2 23,302 2,000 25,600 9,506 37,106 14,84
2 10,460
b. Lease
End of Year Lease After-Tax
Cash Outflows Purchase After-
Tax Cash
Outflows
1 $11,880 $13,622
2 11,880 10,460
Present value of cash outflows
c. The present value of the cash outflows is less with the purchasing plan, so the firm should
purchase the machine. By doing so, it saves $2,820.95 in present value terms.
P17-6. Personal finance problem: Lease-versus-purchase decision
LG 2; Intermediate
a. Total leasing costs
Down payment
Opportunity cost of down payment and security deposita
$ 3,000
495
b. Purchase cost
Down payment
Sales tax (6.5%)
$ 2,640
2,145
a3 years 5% $3,330 $495
should she want to sell the car earlier or retain it after three years.
P17-7. Capitalized lease values
LG 2; Intermediate
Lease Calculator Inputs Capitalized
Value
AN 12, I 10%, PMT
$40,000 $272,547.67
BN 8, I 12%, PMT
EN 20, I 11%, PMT $47,000 374,276.42
P17-8. Conversion price
LG 3; Basic
a. $1,000 40 shares $25 per share
P17-9. Conversion ratioLG 3; Basic
a. $1,000 $43.75 22.86 shares
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
A22.50$42.25
$950.625
P17-12. Straight bond values
LG 4; Intermediate
Bond Years Payments Interest Rate on
Equal-Risk Straight
Bond
Straight
Bond Value
A11
9$ 60 7% $894.06
20 1,060
30 1,080
P17-13. Determining values—convertible bond
LG 4; Challenge
a.
Years Payments Discount Rate Straight Bond Value
20 1,100
b. Conversion value 50 sharesmarket price
50$15 $750
50$20 $1,000
c.
Share Price Minimum
Expected
Bond
Value
$15 $850.61
20 1,000.00
As the share price increases, the bond will start trading at a premium to the pure bond value due to
d. The minimum bond value is $850.61. The bond will not sell for less than the straight bond value
but could sell for more.
17-14. Determining values–convertible bond
LG 4; Challenge
a. Straight Bond Value
Years Payments Discount
Rate Straight Bond
Value
1–14 $ 80 10% $847.88
15 1,080
b. Conversion value
$9.00 80 $720
12.00 80 $960
c.
Share Price Minimum
Bond Value
.00 $ 847.88 (Bond will not sell below straight bond
value)
As the share price increases the bond will start trading at a premium to the pure bond value due to
d.
Up to Point X, the straight bond value is the minimum market value. For stock prices above Point
upward-sloping line. That is, the bond will sell above it conversion value much of the time.
P17-15. Implied price of attached warrants
LG 5; Intermediate
Implied price of all warrants price of bond with warrants straight bond value
=
i m p l i e d p r i c e o f a l l w a r r a n t s
P r i c e p e r w a r r a n t n u m b e r o f w a r r a n t s
Straight bond value:
Bond Years Payments Discount
Rate Straight
Bond Values
A 1–14 $ 120 13% $935.38
15 1,120
20 550
D 1–19 $ 110 12% $925.31
20 1,110
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
B 1,100 – 858.74 241.26 30 8.04