Chapter 16: Long-Term Debt and Lease Financing
a) Operating lease
i. $48,055
ii. $48,055
iii. ($10,000 + $15,000 + $20,000 +$25,000) /4 =
$17,500
iv. $0 Interest not applicable to operating leases.
v. $0 amortization not applicable to operating leases.
b) Finance lease
i. $48,055
ii. $48,055
iii. $0 lease expense not applicable to finance leases.
iv. ($48,055 x .07) = $3364
COMPREHENSIVE PROBLEM
Comprehensive Problem 1.
Broadband Inc. Bond prices refunding (LO16-2 and 3) Barton Simpson, the chief financial
officer of Broadband Inc. could hardly believe the change in interest rates that had taken place
over the last few months. The interest rate on A2 rated bonds was now 6 percent. The $30
Chapter 16: Long-Term Debt and Lease Financing
percent and a 4 percent discount rate will be applied for the refunding decision. The new bond
would have a 10-year life.
Before Barton used the 8 percent call provision to reacquire the old bonds, he wanted to make
sure he could not buy them back cheaper in the open market.
a. First compute the price of the old bonds in the open market. Use the valuation procedures for
a bond that were discussed in Chapter 10 (use the annual analysis). Determine the price of a
single $1,000 par value bond.
b. Compare the price in part a to the 8 percent call premium over par value. Which appears to
be more attractive in terms of reacquiring the old bonds?
c. Now do the standard bond refunding analysis as discussed in this chapter. Is the refunding
financially feasible?
d In terms of the refunding decision, how should Barton be influenced if he thinks interest rates
might go down even more?
Chapter 16: Long-Term Debt and Lease Financing
Chapter 16: Long-Term Debt and Lease Financing
Appendix
16A–1. Settlement of claims in bankruptcy liquidation (LO16-5) The trustee in the
bankruptcy settlement for Titanic Boat Co. lists the following book values and
liquidation values for the assets of the corporation. Liabilities and stockholders’ claims
are shown.
Liquidation
Assets Book Value Value
Accounts receivable …………………… $1,400,000 $1,200,000
Inventory …………………………………………..
1,800,000
900,000
Machinery and equipment …………………..
1,100,000
600,000
Building and plant …………………………..
4,200,000
2,500,000
Total assets
$8,500,000
$ 5,200,000
Liabilities and Stockholders’ Claims
Liabilities:
Accounts payable …………………………..
$2,800,000
First lien, secured by
machinery and equipment ……………..
900,000
Senior unsecured debt ………………………
2,200,000
Subordinated debenture ……………………
1,700,000
Total liabilities …………………………..
7,600,000
Stockholders’ claims:
Preferred stock …………………………..
250,000
Common stock …………………………..
650,000
Total stockholders’ claims …………….
900,000
Total liabilities and
stockholders’ claims ……………… $8,500,000
a. Compute the difference between the liquidation value of the assets and the liabilities.
b. Based on the answer to part a, will preferred stock or common stock participate in
the distribution?
c. Assuming the administrative costs of bankruptcy, workers’ allowable wages, and
unpaid taxes add up to $400,000, what is the total remaining asset value available to
cover secured and unsecured claims?
d. After the machinery and equipment are sold to partially cover the first lien secured
claim, how much will be available from the remaining asset liquidation values to
cover unsatisfied secured claims and unsecured debt?
Chapter 16: Long-Term Debt and Lease Financing
e. List the remaining asset claims of unsatisfied secured debt holders and unsecured
debt holders in a manner similar to that shown in the bottom portion of Table 16A-3.
f. Compute a ratio of your answers in part d and e. This will indicate the initial
allocation ratio.
g. List the remaining claims (unsatisfied secured and unsecured) and make an initial
allocation and final allocation similar to that shown in Table 16A-4. Subordinated
debenture holders may keep the balance after full payment is made to senior debt
holders.
h. Show the relationship of amount received to total amount of claim in a similar
fashion to that in Table 16A-5. Remember to use the sales (liquidation) value for
machinery and equipment plus the allocation amount in part g to arrive at the total
received on secured debt.
16A–1. Solution:
Titanic Boat Co.
a. Liquidation value of assets $5,200,000
Liabilities 7,600,000
Difference ($2,400,000)
b. Preferred and common stock will not participate in the
Chapter 16: Long-Term Debt and Lease Financing
unsecured debt holder
Secured debt (unsatisfied first lien) $ 300,000
Accounts payable 2,800,000
Senior unsecured debt 2,200,000
Subordinated debentures 1,700,000
$7,000,000
f. Amount available to unsatisfied
$4,200,000
security claims and unsecured debt (part d) 60%
Remaining claims of unsatisfied secured $7,000,000
debt and unsecured debt holders (part e)
==
Chapter 16: Long-Term Debt and Lease Financing
CP16A-1. (Continued)
g.
Allocation procedures for unsatisfied secured claims and
unsecured debt.
(1)
Category
(2)
Amount of
Claim
(3)
Initial
Allocation
(60%)
(4)
Amount
Received
Secured ebt
(unsatisfied first lien)
$ 300,000
$ 180,000
$ 180,000
Accounts Payable
2,800,000
1,680,000
1,680,000
Senior unsecured debt
2,200,000
1,320,000
2,200,000
Subordinated
debentures*
1,700,000
1,020,000
140,000*
$ 7,000,000
$4,200,000
$4,200,000
* The subordinated debenture holders must transfer $880,000
of their initial allocation to the senior unsecured debt holders
to fully provide for their payment ($1,320,000 + $880,000 =
$2,200,000). This will leave $140,000 for subordinated
debentures ($1,020,000 – $880,000).
Chapter 16: Long-Term Debt and Lease Financing
CP16A-1. (Continued)
h.
Payments and percent of claims
Category
Total Amount
of Claim
Amount
Received
Percent of
Claim
Satisfied
Secured debt
(first lien)
$ 900,000
$ 780,000
86.7%
Accounts
payable
2,800,000
1,680,000
60.0%
Senior
unsecured
debt
2,200,000
2,200,000
100.0%
Subordinated
debentures
1,700,000
140,000
8.2%
16B-1. Lease versus purchase decision (LO16-4) Howell Auto Parts is considering whether
to borrow funds and purchase an asset or to lease the asset under an operating lease
arrangement. If the company purchases the asset, the cost will be $10,000. It can borrow
funds for four years at 12 percent interest. The firm will use the three-year MACRS
depreciation category (with the associated four-year write-off). Assume a tax rate of
35 percent.
The other alternative is to sign two operating leases, one with payments of $2,600 for
the first two years, and the other with payments of $4,600 for the last two years. In your
analysis, round all values to the nearest dollar.
a. Compute the aftertax cost of the leases for the four years.
b. Compute the annual payment for the loan (round to the nearest dollar).
c. Compute the amortization schedule for the loan. (Disregard a small difference
from a zero balance at the end of the loan due to rounding.)
d. Determine the depreciation schedule (see Table 12-9).
e. Compute the aftertax cost of the borrow-purchase alternative.
f. Compute the present value of the aftertax cost of the two alternatives. Use a
discount rate of 8 percent.
g. Which alternative should be selected, based on minimizing the present value of
aftertax costs?
Chapter 16: Long-Term Debt and Lease Financing
d. Depreciation Depreciation
Year
Base
Percentage
Depreciation
1
$10,000
.333
$ 3,330
2
10,000
.445
4,450
3
10,000
.148
1,480
4
10,000
.074
740
$10,000
e.
(1)
(2)
(3)
(4)
(5)
(6)
Year
Payment
Interest
Depreciation
Total Tax
Deductions
Tax
Shield
35% × (4)
Net
Aftertax
Cost (1)
– (5)
1
$3,293
$1,200
$3,330
$4,530
$1,586
$1,707
2
3,293
949
4,450
5,399
1,890
1,403
3
3,293
668
1,480
2,148
752
2,541
4
3,293
353
740
1,093
383
2,910
CP16B-1. (Continued)
f.
Year
Aftertax
Cost of
Leasing
PV
Factor
at 8%
Present
Value
Aftertax
Cost of
Borrow-
Purchase
PV
Factor
at 8%
Present
Value
1
$1,690
.926
$1,565
$1,707
.926
$1,581
2
1,690
.857
1,448
1,403
.857
1,202
3
2,990
.794
2,374
2,541
.794
2,018
4
2,990
.735
2,198
2,910
.735
2,139
$7,585
$6,940
Chapter 16: Long-Term Debt and Lease Financing