Leasing/Hybrid Financing Name_____An Gia Kou________________________

FIN 4310
Spring 2020 BE SURE TO SHOW YOUR WORK!
1. Welbilt is negotiating to lease small trailers with Delta Leasing. The firm has received an
offer from Wells Cargo for a total purchase price of $1,100,000. The terms of the lease
include four payments of $290,000, with each payment occurring at the beginning of
the year. An alternative to leasing is to borrow the money and buy the trailers. The
$1,100,000 loan for four years has an annual interest rate of 8%. Assume the trucks fall
into the MACRS 3-year class and have an expected residual value of $150,000. The
applicable depreciation rates are .3333, .4445, .1481 and .0741. Maintenance costs
would be included in the lease. If the trailers are purchased, a maintenance contract
would be bought at the beginning of each year for $16,000 annually. Welbilt plans to
buy a new set of trailers at the end of the fourth year. The firm has an effective tax rate
of 21%.
a). What is Welbilt’s present value of the cost of owning?

0 1 2 3 4
AT Loan PMT -69520 -69520 -69520 -69520 -69520
Dep Shield 76992.3 102,679.50 34,211.10 17,117.10
Maintanance -16,000 -16,000 -16,000 -16,000 -16,000
Tax Saving 3,360 3,360.00
3,360.00 3,360.00 3,360.00
Residue Value 150,000
Tax -31,500
NCF (1,033,902.90)
(12,640.00) (5,167.70) (20,520.00) (47,949.00)

NPV
(884,682.90)

b.) What is Welbilt’s present value of the cost of leasing?

Initial lease payment = $290,000
After tax lease payment = $290,000*(1-0.21)= $229,100
After tax cost debt = 8%(1-0.21)= 6.32%
N= 4 years

0 1 2 3 4
lease payment
(290,000.00) (290,000.00) (290,000.00) (290,000.00) (290,000.00)
maintenance fee
(16,000.00) (16,000.00) (16,000.00) (16,000.00) (16,000.00)
 CF
(306,000.00) (306,000.00) (306,000.00) (306,000.00) (306,000.00)
tax saving= tax
rate*CF 64,260.00 64,260.00 64,260.00 64,260.00 64,260.00
NI
(241,740.00) (241,740.00) (241,740.00) (241,740.00) (241,740.00)
NPV cost of
leasing (1,073,293.04)

c.) What is Welbilt’s Net Advantage to Leasing (NAL)?

NAL=(884,682.90)-(1,073,293.04)=188610.14

Assume all bonds in problems 2 through 11 pay interest on an ANNUAL basis. The purpose of
the remainder of this assignment is to estimate the value of warrants and convertible bonds.
2. Valesco Corp. has just sold a bond issue with 15 warrants attached to each bond. The
bonds have a 10-year maturity, an annual coupon rate of 8%. They sold at an original offering
price of $1,000. The current yield-to-maturity of bonds of equal risk, but without warrants is
10%. What is the value of each warrant?
I= 10%
N=10 years
PMT= 0.08*1000
FV=1000
PV=$877.11
V(package)= V(bond)+ V(warrant)
$1000= 15(?)+877.11-→ value of each warrant= (1000-877.11)/15= $8.19/ warrant

3. Apple is considering the issuance of a 10-year convertible bond that will be priced at par
value of $1,000 per bond. The bonds carry a 6% annual coupon interest rate and can be
converted into 30 common shares. The shares are currently priced at $25 per share, with an
expected annual dividend of $2 and is growing at a constant 3% annual rate. The bonds are
callable after 5 years at $1,030, with the price declining by $5 per year. If, after 10 years, the
conversion exceeds the call price by at least 20%, management is likely to call the bonds.
What is the conversion price?
Conversion ratio= par value/ conversion price
-→ conversion price= 1000/30=$33.33/ share

4. Refer to problem 3 above. If the yield-to-maturity on the non-convertible bonds of similar

risk is 11%, what is the straight debt value of this convertible bond?
N=10
I=11%
PV=?-→ 705.54
PMT=1000*0.06
FV=1000

5. Refer to problem 3 above. If an investor expects the bond issue to be called in year 5 and
he or she plans on converting it at that time, what is the investor’s expected rate of return
upon conversion?
CV(t=5)= CR*P(0)*(1+g)^t= 30*25*(1+0.03)^5=869.46
N=5
I=?-→ I=3.57%
PV=1000
PMT=1000*0.06=60
FV=869.46

6. Disney intends to issue $70 million in capital to fund new opportunities. If the firm decides
to issue the new capital in the form of a straight debt 20-year bond offering, an 5% coupon
would be required. An alternative would be to include 25 warrants per $1,000 bond attached
to the bonds that would reduce the coupon to 4%. The firm has 10 million common shares
outstanding with a current price of $20.00 per share. The warrants could be exercised at any
time after 10 years at an exercise price of $23.50 per share.
After issuing the bonds and the warrants, Genesis’ operations and investments are expected
to grow at a constant rate of 5% per year. If investors are willing to pay $1,000 for each bond,
what is the value of each warrant attached to the bond issue?
N=20
I=?--> 5%
PV=1000
FV=1000
PMT=1000*0.05=50

N=20
PMT=40
PV=1000
I=5%
FV=?--> = 875.39

Value of each warrant= (1000-875.39)/25= 4.98

7. Refer to problem 6 above. What is the expected total value of Disney in 10 years?
N=10
PMT=40
PV=?--> 922.79
I=5%
FV=1000
Debt= 922.79*70,000=64,595,300
Cash= 23.50*70,000*25=41,125,000
270,000,000*(1.05)^10+41,125,000-64,595,300=416331249.2
8. Refer to problem 6 above. Assuming the warrants weren’t exercised, what would be
Disney’s expected common share price in 10 years?
20*(10.05)^10=32.59

9. Refer to problem 6. What would be the price per share in 10 years with the warrants?
32.59+4.98=37.57

10. Refer to problem 6. What is the component cost of these bonds with warrants?
(35.43-23.)*25=298.25
Kw: N=10
PV=?--> 124.62
FV=298.25
I=9.12%
Kd: I=5%
(875.38/1000)*5%+(124.62/1000)*9.12%=0.0551→5.51%

11. Refer to problem 6 and problem 10 (above). What is the premium to the component cost
associated with using the bonds with warrants as compared with straight debt?
5.51%-5%=0.51%