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I. Questions 1. Capitalizing lease payments means computing the present value of future lease payments and showing them as an asset and liability on the balance sheet. 2. The preemptive right provides current shareholders with a first option to buy new shares. In this fashion, their voting right and claim to earnings cannot be diluted without their consent. 3. The actual owners have the last claim to any and all funds that remain. If the firm is profitable, this could represent a substantial amount. Thus, the residual claim may represent a privilege as well as a potential drawback. Generally, other providers of capital may only receive a fixed amount. 4. Preference share is a “hybrid” or intermediate form of security possessing some of the characteristics of debt and ordinary shares. The fixed amount provision is similar to debt, but the noncontractual obligation is similar to ordinary shares. Though the preference shareholder does not have an ownership interest in the firm, the priority of claim is higher than that of the ordinary shareholder. 5. With the cumulative feature, if preference share dividends are not paid in any one year, they accumulate and must be paid in total before ordinary shareholders can receive dividends. Even though preference share dividends are not a contractual obligation as is true of interest on debt, the cumulative feature tends to make corporations very aware of obligations to preference shareholders. Preference shareholders may even receive new securities for forgiveness of missed dividend payments. II. Multiple Choice 1. B 11. C 20-1 21. B 31. C

18. 17. A C B A Supporting computations: 8. 24. 9. 20. 33. and I0 equals the market rate as in case of a new issue the net proceeds of P47 P9 (P50 − P3). 8. 4.4) + ½ 18% = 11. g equals the expected growth rate in dividends and I 0 I0 P80 equals the value of the shares. 25. 14.16 12. 16. Options. C D D A C D D D A 12. 19.48 P4.15% 10.48 (P4 x 1. D A C B D D B D A 22.Chapter 20 Hybrid Financing: Preference Shares. 30. 23. Leasing.10 . 26. 5. 28.20 . 29. 35. and Convertibles 2. where D1 equals the expected dividend one period from today (P9). 6. 13.03 . 27. Warrants.50 WAC . Cost of retained earnings = = 17. which is P4. k p = = = 19. 34. D1 I0 P47 Source LT debt PS CE Cost 10% 15% 20% Weight . 15. The weighted average cost of capital (WACCAT) is: k0t = Wiki (1 − Tc) + Weke = ½ 9% (1 − .12).03 .7% 20-2 .30 .6% + g = + 12% D1 where D1 equals the expected dividends one period from today. 9. 10. 3. 7. B C A B D C B A C 32.