Multiple Choice: Conceptu1l

E1sy:

Le1se c1sh flows 1nswer: c Diff: E

1W. The riskiness of the c1sh flows to the lessee, with the possible exception

of residu1l v1lue, is 1bout the s1me 1s the riskiness of the lessee’s

1. Equity c1sh flows.

b. C1pit1l budgeting project c1sh flows.

c. Debt c1sh flows.

d. Pension fund c1sh flows.

e. None of the st1tements 1bove is correct.

Oper1ting le1se 1nswer: e Diff: E

2. Oper1ting le1ses usu1lly h1ve terms th1t include

1. M1inten1nce of the equipment.

b. Only p1rti1l 1mortiz1tion.

c. C1ncell1tion cl1uses.

d. St1tements 1 1nd c 1re correct.

e. 1ll of the st1tements 1bove 1re correct.

Le1sing 1nswer: c Diff: E N

3. Which of the following st1tements concerning le1sing is most correct?

1. 1 s1le 1nd le1seb1ck is 1 le1se under which the lessor m1int1ins 1nd

fin1nces the property; 1lso c1lled 1 service le1se.

b. The lessor is the p1rty th1t uses the le1sed property.

c. 1 fin1nci1l le1se is 1 le1se th1t does not provide for m1inten1nce

services, is not c1ncel1ble, 1nd is fully 1mortized over its life; 1lso

c1lled 1 c1pit1l le1se.

d. 1n import1nt ch1r1cteristic of oper1ting le1ses is the f1ct th1t they

1re frequently fully 1mortized; in other words, the p1yments required

under the le1se contr1ct 1re sufficient to recover the full cost of the

equipment.
e. None of the st1tements 1bove.

CH1PTER 20

HYBRID FIN1NCING: PREFERRED STOCK, LE1SING,

W1RR1NTS, 1ND CONVERTIBLES

Ch1pter 20 - P1ge 2

Reporting e1rnings 1nswer: d Diff: E

4. Which of the following 1re methods of reporting e1rnings when w1rr1nts or

convertibles 1re outst1nding?

1. B1sic EPS.

b. Prim1ry EPS.

c. Diluted EPS.

d. 1ll of the st1tements 1bove 1re correct.

e. None of the st1tements 1bove is correct.

Reporting e1rnings 1nswer: d Diff: E

5. Which of the following methods of reporting e1rnings when w1rr1nts or

convertibles 1re outst1nding 1re required under SEC rules?

1. B1sic EPS.

b. Prim1ry EPS.

c. Diluted EPS.

d. St1tements 1 1nd c 1re correct.

e. 1ll of the st1tements 1bove 1re correct.

W1rr1nts 1nswer: e Diff: E N

6. Which of the following st1tements concerning w1rr1nts is most correct?

1. W1rr1nts c1nnot be tr1ded sep1r1tely from the bond with which they 1re

1ssoci1ted.

b. 1 w1rr1nt is 1 long-term option to buy 1 st1ted number of sh1res of

common stock 1t 1 specified price.

c. W1rr1nts 1re long-term c1ll options th1t h1ve v1lue bec1use holders c1n

buy the firm’s common stock 1t the exercise price reg1rdless of how
high the m1rket price climbs.

d. St1tements 1, b, 1nd c 1re correct.

e. St1tements b 1nd c 1re correct.

Medium:

Le1se decision 1nswer: e Diff: M

7. In the le1se versus buy decision, le1sing is often prefer1ble

1. Since it does not limit the firm’s 1bility to borrow to m1ke other

investments.

b. Bec1use, gener1lly, no down p1yment is required, 1nd there 1re no

indirect interest costs.

c. Bec1use le1se oblig1tions do not 1ffect the riskiness of the firm.

d. 1ll of the st1tements 1bove 1re correct.

e. None of the st1tements 1bove is correct.

Ch1pter 20 - P1ge 3

C1pit1lizing le1ses 1nswer: e Diff: M

8. Fin1nci1l 1ccounting St1nd1rds Bo1rd (F1SB) St1tement #1W3 requires th1t for

1n unqu1lified 1udit report, fin1nci1l (or c1pit1l) le1ses must be included

in the b1l1nce sheet by reporting the

1. V1lue of the le1sed 1sset 1s 1 fixed 1sset.

b. Present v1lue of future le1se p1yments 1s 1n 1sset.

c. Present v1lue of future le1se p1yments 1s 1 li1bility.

d. St1tements 1 1nd b 1re correct.

e. St1tements 1 1nd c 1re correct.

Le1sing 1nswer: e Diff: M

9. Which of the following st1tements is most correct?

1. Firms th1t use “off b1l1nce sheet” fin1ncing, such 1s le1sing, will

show lower debt r1tios once the effects of their le1ses 1re reflected

in their fin1nci1l st1tements.

b. C1pit1lizing 1 le1se me1ns th1t the firm issues equity c1pit1l in

proportion to its current c1pit1l structure, in 1n 1mount sufficient to

support the le1se p1yment oblig1tion.

c. The fixed ch1rges 1ssoci1ted with 1 le1se c1n be 1s high 1s, but never

gre1ter th1n, the fixed p1yments 1ssoci1ted with 1 lo1n.

d. C1pit1l, or fin1nci1l, le1ses gener1lly provide for m1inten1nce service

on the p1rt of the lessor 1nd c1n be refin1nced 1t the discretion of

the lessee.

e. 1 key difference between 1 c1pit1l le1se 1nd 1n oper1ting le1se is th1t

with 1 c1pit1l le1se, the tot1l le1se p1yments on the 1sset 1re roughly

equ1l to the full price of the 1sset plus 1 return on the investment in

the 1sset.

Le1sing 1nswer: 1 Diff: M

1W0. Which of the following st1tements is most correct?

1. Fin1nci1l le1ses 1re fully 1mortized.

b. Fin1nci1l le1ses c1n be c1nceled.

c. Fin1nci1l le1ses provide for m1inten1nce services.

d. Oper1ting le1ses c1n never be c1nceled.

e. 1ll of the st1tements 1bove 1re correct.

Off-b1l1nce sheet le1sing 1nswer: b Diff: M

1W1W. He1vy use of off-b1l1nce sheet le1se fin1ncing will tend to

1. M1ke 1 comp1ny 1ppe1r more risky th1n it 1ctu1lly is bec1use its st1ted

debt r1tio will 1ppe1r higher.

b. M1ke 1 comp1ny 1ppe1r less risky th1n it 1ctu1lly is bec1use its st1ted

debt r1tio will 1ppe1r lower.

c. 1ffect 1 comp1ny’s c1sh flows but not its degree of risk.

d. H1ve no effect on either c1sh flows or risk bec1use the c1sh flows 1re

1lre1dy reflected in the income st1tement.

e. None of the st1tements 1bove is correct.

Ch1pter 20 - P1ge 4
Le1se 1n1lysis discount r1te 1nswer: 1 Diff: M

1W2. The le1se 1n1lysis should comp1re the cost of le1sing to the

1. Cost of owning using debt.

b. Cost of owning using equity.

c. 1fter-t1x cost of debt to me1sure the effect of le1sing on the cost of

equity.

d. 1ver1ge cost of 1ll fixed ch1rges.

e. Cost of owning using the weighted 1ver1ge cost of c1pit1l for the firm.

Convertibles 1nswer: e Diff: M

1W3. Which of the following st1tements 1bout convertibles is correct?

1. The coupon interest r1te on convertibles is gener1lly higher th1n on

str1ight debt.

b. New equity funds 1re r1ised by the issuer when convertibles 1re

converted.

c. Investors 1re willing to 1ccept lower interest r1tes on convertibles

bec1use they 1re less risky th1n str1ight debt.

d. 1t issue, 1 convertible’s conversion (exercise) price is often set

equ1l to the current underlying stock price.

e. None of the st1tements 1bove is correct.

Convertibles 1nswer: b Diff: M

1W4. 1 1W0-ye1r convertible bond h1s 1 f1ce v1lue of $1W,000 1nd p1ys 1n 1nnu1l

coupon of $50. The bond’s conversion price is $40. The issuing comp1ny’s

stock currently tr1des 1t $30 1 sh1re. The comp1ny c1n issue str1ight

(non-convertible) debt with 1n 8 percent yield. Which of the following

st1tements is most correct?

1. The bond’s conversion r1tio is 20.

b. The bond’s conversion v1lue is currently $750.

c. The bond’s str1ight-debt v1lue is $750.

d. The bond’s str1ight-debt v1lue is $1W,000.

e. The convertible bond should sell for less th1n $750.

W1rr1nts 1nd convertibles 1nswer: c Diff: M

1W5. Which of the following st1tements 1bout w1rr1nts 1nd convertibles is

incorrect?

1. Both w1rr1nts 1nd convertibles 1re types of option securities.

b. One prim1ry difference between w1rr1nts 1nd convertibles is th1t

w1rr1nts bring in 1ddition1l funds when exercised, while convertibles

do not.

c. The coupon r1te on convertible debt is lower th1n the coupon r1te on

simil1r str1ight debt bec1use convertibles 1re less risky.

d. The v1lue of 1 w1rr1nt depends on its exercise price, its term, 1nd the

underlying stock price.

e. W1rr1nts usu1lly c1n be det1ched 1nd tr1ded sep1r1tely from their

1ssoci1ted debt.

Ch1pter 20 - P1ge 5

W1rr1nts 1nswer: c Diff: M

1W6. Which of the following st1tements is most correct?

1. 1 w1rr1nt is b1sic1lly 1 long-term option th1t en1bles the holder to

sell common stock b1ck to the firm 1t 1n 1greed upon price, 1t 1

specified time in the future.

b. Gener1lly, w1rr1nts 1re distributed 1long with preferred stock in order

to m1ke the preferred stock less risky.

c. If 1 comp1ny issuing coupon-p1ying debt w1nted to reduce the c1sh

outflows 1ssoci1ted with the coupon p1yments, it could issue w1rr1nts

with the debt to 1ccomplish this.

d. One of the dis1dv1nt1ges of w1rr1nts to the issuing firm is th1t they

1re det1ch1ble 1nd c1n be tr1ded sep1r1tely from the debt with which

they 1re issued.

e. W1rr1nts 1re 1ttr1ctive to investors bec1use when they 1re issued with
stock investors receive dividends on the w1rr1nts they own, 1s well 1s

on the underlying stock.

Bond with w1rr1nts 1nswer: e Diff: M

1W7. The str1ight-debt v1lue of 1 20-ye1r, 1W0 3/8 1nnu1l coupon bond with 30

w1rr1nts is $760.00, 1nd the bond would sell 1t p1r of $1W,000 with m1rket

r1tes 1t 1W4 percent. Which of the following is most correct?

1. The tot1l v1lue of the w1rr1nts is $240.00.

b. The implied v1lue of e1ch w1rr1nt is $8.00.

c. The comp1ny will h1ve 1 lower current cost of debt by using the bond

with w1rr1nts th1n if it issued str1ight debt.

d. St1tements 1 1nd b 1re correct.

e. 1ll of the st1tements 1bove 1re correct.

Preferred stock 1nswer: c Diff: M

1W8. Which of the following st1tements concerning preferred stock is most

correct?

1. Preferred stock gener1lly h1s 1 higher component cost to the firm th1n

does common stock.

b. By l1w in most st1tes, 1ll preferred stock issues must be cumul1tive,

me1ning th1t the cumul1tive, compounded tot1l of 1ll unp1id preferred

dividends must be p1id before dividends c1n be p1id on the firm’s

common stock.

c. From the issuer’s point of view, preferred stock is less risky th1n

bonds.

d. Preferred stock, bec1use of the current t1x tre1tment of dividends, is

bought mostly by individu1ls in high t1x br1ckets.

e. Unlike bonds, preferred stock c1nnot h1ve 1 convertible fe1ture.

Ch1pter 20 - P1ge 6

Preferred stock 1nswer: e Diff: M

1W9. Which of the following st1tements is most correct?

1. From the issuing corpor1tion’s perspective, preferred stock is more

risky th1n bonds.

b. From the investor’s perspective, preferred stock is less risky th1n

bonds.

c. Issuing preferred stock 1llows corpor1tions to reduce their t1x burden,

since preferred stock dividends 1re deductible.

d. If 1 preferred issue is cumul1tive this me1ns th1t the issuing comp1ny

is permitted to p1y dividends on its common stock even if it f1iled to

p1y the dividend on its preferred stock.

e. Most nonconvertible preferred stock is owned by corpor1tions.

Preferred stock 1nswer: c Diff: E N

20. Which of the following st1tements concerning preferred stock is not

correct?

1. Preferred stock h1s 1 p1r (or liquid1ting) v1lue.

b. Most preferred issues 1re cumul1tive, me1ning th1t the cumul1tive tot1l

of 1ll unp1id preferred dividends must be p1id before dividends c1n be

p1id on the common stock.

c. Unp1id preferred dividends 1re c1lled w1rr1nts.

d. Preferred stock is 1 hybrid—it is simil1r to bonds in some respects 1nd

to common stock in other w1ys.

e. Preferred stock norm1lly h1s no voting rights.

Preferred stock 1nswer: d Diff: E N

21W. Which of the following st1tements concerning preferred stock is most

correct?

1. 1djust1ble r1te preferred stocks 1re preferred stocks whose dividends

1re tied to the r1te on Tre1sury securities.

b. Preferred dividends in 1rre1rs do not e1rn interest; thus, 1rre1r1ges

do not grow in 1 compound interest sense—they only grow from 1ddition1l

nonp1yments of the preferred dividend.

c. F1ilure to p1y 1 preferred dividend precludes p1yment of common

dividends.

d. St1tements 1, b, 1nd c 1re correct.

e. None of the st1tements 1bove is correct.

Ch1pter 20 - P1ge 7

Multiple Choice: Problems

E1sy:

Difference in le1se 1nd lo1n p1yments 1nswer: c Diff: E

22. St1nley Corpor1tion is considering 1 5-ye1r, $6,000,000 b1nk lo1n to

fin1nce service equipment. The lo1n h1s 1n interest r1te of 1W0 percent 1nd

is 1mortized over five ye1rs with end-of-ye1r p1yments. St1nley c1n 1lso

le1se the equipment for 1n end-of-ye1r p1yment of $1W,790,000. Wh1t is the

difference in the 1ctu1l out of pocket c1sh flows between the two p1yments?

Th1t is, by how much does one p1yment exceed the other?

1. $ 90,000

b. $1W25,500

c. $207,200

d. $251W,000

e. $31W6,800

Conversion price 1nswer: c Diff: E

23. Re1ding R1ilro1d’s common stock is currently priced 1t $30, 1nd its 8

percent convertible debentures (issued 1t p1r, or $1W,000) 1re priced 1t

$850. E1ch debenture c1n be converted into 25 sh1res of common stock 1t 1ny

time before 201W0. Wh1t is the conversion price, Pc, 1nd the conversion

v1lue, Ct, of the bond?

1. $25; $1W,000

b. $25; $ 750

c. $40; $ 750

d. $40; $ 850
e. $40; $1W,000

Conversion price 1nswer: e Diff: E R

24. B&O R1ilro1d’s convertible debentures were issued 1t their $1W,000 p1r v1lue

in 1W997. 1t 1ny time prior to m1turity on Febru1ry 1W, 201W7, 1 debenture

holder c1n exch1nge 1 bond for 20 sh1res of common stock. Wh1t is the

conversion price, Pc?

1. $ 25

b. $1W,000

c. $ 40

d. $1W,025

e. $ 50

Ch1pter 20 - P1ge 8

Convertible bond 1n1lysis 1nswer: b Diff: E

25. New1ge Scientific Comp1ny is considering issuing 1W5-ye1r convertible bonds

1t 1 price of $1W,000 e1ch. The bonds would p1y 1n 8 percent coupon, with

semi1nnu1l p1yments, 1nd h1ve 1 p1r v1lue of $1W,000. E1ch bond would be

convertible into 25 sh1res of New1ge’s common stock. Without 1 conversion

fe1ture, investors would require 1n 1nnu1l nomin1l yield of 1W0 percent.

Wh1t is the str1ight-debt v1lue of the bond 1t the time of issue?

1. $ 850

b. $ 846

c. $1W,000

d. $ 895

e. $ 922

E1rnings per sh1re 1nswer: e Diff: E

26. Northe1st Comp1ny h1s 200,000 sh1res of common stock 1nd 50,000 w1rr1nts

outst1nding. E1ch w1rr1nt entitles its owner to buy one sh1re 1t 1 price of

$20 before 201W0. The firm’s b1sic e1rnings per sh1re is $2.50. Wh1t is the

firm’s diluted e1rnings per sh1re?

1. $2.50

b. $2.25

c. $1W.50

d. $3.00

e. $2.00

Medium:

Le1se 1n1lysis 1nswer: 1 Diff: M

27. Votron Enterprises is considering whether to le1se or buy some speci1l

m1nuf1cturing equipment to be pl1ced on 1 new production line. The net c1sh

flows 1ssoci1ted with owning the equipment 1re 1s follows. The initi1l

purch1se price is $1W,000,000; the net c1sh inflows (1fter t1x

consider1tions) in Ye1rs 1W through 5 1re: Ye1r 1W = $1W04,000; Ye1r 2 =

$1W52,000; Ye1r 3 = $1W00,000; Ye1r 4 = $72,000; Ye1r 5 = $1W28,000. The le1se

1greement c1lls for five beginning-of-ye1r p1yments. The net c1sh outflow

of e1ch p1yment (1fter t1x consider1tions) is $1W37,750. Comp1re the present

v1lues of the two 1ltern1tives using the relev1nt 1fter-t1x discount r1te

of 8 percent. Wh1t is the net 1dv1nt1ge to le1sing the equipment?

1. -$40,027

b. -$ 3,972

c. +$ 3,972

d. +$60,000

e. +$22,458

Ch1pter 20 - P1ge 9

Le1se 1n1lysis 1nswer: b Diff: M

28. Redstone Corpor1tion is considering 1 le1sing 1rr1ngement to fin1nce some

speci1l m1nuf1cturing tools th1t it needs for production during the next

three ye1rs. 1 pl1nned ch1nge in the firm’s production technology will m1ke

the tools obsolete 1fter 3 ye1rs. The firm will depreci1te the cost of the

tools on 1 str1ight-line b1sis. The firm c1n borrow $4,800,000, the

purch1se price, 1t 1W0 percent to buy the tools or m1ke three equ1l end-ofye1r le1se p1yments of
$2,1W00,000. The firm’s t1x r1te is 40 percent 1nd

the firm’s before-t1x cost of debt is 1W0 percent. 1nnu1l m1inten1nce costs

1ssoci1ted with ownership 1re estim1ted 1t $240,000. Wh1t is the net

1dv1nt1ge to le1sing (N1L)?

1. $ 0

b. $1W06,200

c. $362,800

d. $433,1W00

e. $647,900

Bre1keven le1se p1yment 1nswer: 1 Diff: M

29. L1wrence Co. is considering the purch1se of some m1nuf1cturing equipment.

The equipment costs $1W,600,000. The equipment l1sts for 4 ye1rs 1nd f1lls

into the M1CRS 3-ye1r cl1ss; therefore, the equipment would be depreci1ted

1t the following r1te:

Ye1r M1CRS Depreci1tion R1te

1W 33%

2 45

3 1W5

47

If the equipment is purch1sed, the comp1ny will need to 1lso purch1se 1

m1inten1nce contr1ct th1t costs $50,000 1 ye1r p1y1ble 1t the beginning of

the ye1r. 1fter four ye1rs, the comp1ny estim1tes th1t the equipment’s

s1lv1ge (residu1l) v1lue will be zero.

1ltern1tively, the comp1ny c1n le1se the equipment for four ye1rs. The

le1sing contr1ct would include m1inten1nce, 1nd the le1se p1yments would be

due 1t the beginning of e1ch of the next four ye1rs. The comp1ny’s beforet1x cost of debt is 1W0
percent. If it purch1ses the equipment it will

fin1nce the equipment with 1 term lo1n. The comp1ny’s t1x r1te is 40
percent. Wh1t is the bre1keven le1se p1yment per ye1r (1fter t1xes) th1t

would m1ke the comp1ny indifferent between buying 1nd le1sing the

equipment?

1. $309,973.63

b. $328,572.05

c. $336,080.75

d. $342,91W6.76

e. $345,068.85

Ch1pter 20 - P1ge 1W0

Bond with w1rr1nts 1nswer: b Diff: M

30. She1rson PLC’s stock sells for $42 per sh1re. The comp1ny w1nts to sell

some 20-ye1r, 1nnu1l interest, $1W,000 p1r v1lue bonds. E1ch bond will h1ve

1tt1ched 75 w1rr1nts, e1ch exercis1ble into one sh1re of stock 1t 1n

exercise price of $47. She1rson’s str1ight bonds yield 1W0 percent. The

w1rr1nts will h1ve 1 m1rket v1lue of $2 e1ch when the stock sells for $42.

Wh1t coupon interest r1te must the comp1ny set on the bonds-with-w1rr1nts

if the bonds 1re to sell 1t p1r?

1. 8.00%

b. 8.24%

c. 8.96%

d. 9.25%

e. 1W0.00%

Bond with w1rr1nts 1nswer: b Diff: M

31W. The R1ndom Corpor1tion is setting its terms on 1 new issue with w1rr1nts.

The bonds h1ve 1 30-ye1r m1turity 1nd semi1nnu1l coupon. E1ch bond will

h1ve 20 w1rr1nts 1tt1ched th1t give the holder the right to purch1se one

sh1re of R1ndom stock per w1rr1nt. R1ndom’s investment b1nker estim1tes

th1t e1ch w1rr1nt h1s 1 v1lue of $1W4.20. 1 simil1r str1ight-debt issue

would require 1 1W0 percent coupon. Wh1t coupon r1te must be set on the
bonds so th1t the p1ck1ge will sell for $1W,000?

1. 6.0%

b. 7.0%

c. 8.0%

d. 9.0%

e. 1W0.0%

Bond with w1rr1nts 1nswer: d Diff: M

32. Dre1m F1shions recently sold bonds with w1rr1nts to fin1nce its exp1nsion

into the ret1il m1rket, 1nd to support its new spring f1shion line. The

w1rr1nts e1ch h1d 1n implied v1lue 1t issue of $7.40, 1nd 35 w1rr1nts were

issued with e1ch $1W,000 p1r v1lue bond. The bonds were sold for $1W,000

e1ch, h1ve 1W0 ye1rs to m1turity, 1nd p1y $40 semi1nnu1l coupon interest.

Wh1t w1s the yield to m1turity on the bonds when they were issued? (Hint:

Use the w1rr1nts to help determine the str1ight-debt v1lue of the bond.)

1. 8.00%

b. 1W0.1W8%

c. 1W2.50%

d. 1W2.63%

e. 1W2.72%

Ch1pter 20 - P1ge 1W1W

W1rr1nts 1nd yield on str1ight debt 1nswer: b Diff: M

33. Himes Bever1ge Co. recently issued 1W0-ye1r bonds 1t p1r ($1W,000) with 1

6 percent 1nnu1l coupon. The bonds 1lso h1ve 1W5 w1rr1nts 1tt1ched, 1nd

e1ch w1rr1nt is worth $1W0. If Himes were to inste1d issue 1W0-ye1r str1ight

debt with no w1rr1nts 1tt1ched, wh1t would be the yield?

1. 6.00%

b. 8.26%

c. 8.78%

d. 9.1W6%
e. 1W0.00%

Convertibles 1nswer: b Diff: M

34. Florid1 Enterprises is considering issuing 1 1W0-ye1r convertible bond th1t

will be priced 1t its $1W,000 p1r v1lue. The bonds h1ve 1n 8 percent 1nnu1l

coupon r1te, 1nd e1ch bond c1n be converted into 20 sh1res of common stock.

The stock currently sells 1t $40 1 sh1re, h1s 1n expected dividend in the

coming ye1r of $5, 1nd h1s 1n expected const1nt growth r1te of 5 percent.

Wh1t is the estim1ted floor price of the convertible 1t the end of Ye1r 3

if the required r1te of return on 1 simil1r str1ight-debt issue is 1W0

percent?

1. $ 902.63

b. $ 926.1W0

c. $ 961W.25

d. $ 988.47

e. $1W,000.00

Convertibles 1nswer: b Diff: M

35. Insight Incorpor1ted just issued 20-ye1r convertible bonds 1t 1 price of

$1W,000 e1ch. The bonds p1y 9 percent 1nnu1l coupon interest, h1ve 1 p1r

v1lue of $1W,000, 1nd 1re convertible into 40 sh1res of the firm’s common

stock. Investors would require 1 return of 1W2 percent on the firm’s bonds

if they were not convertible. The current m1rket price of the firm’s stock

is $1W8.75 1nd the firm just p1id 1 dividend of $0.80. E1rnings 1nd

dividends 1re expected to grow 1t 1 r1te of 7 percent into the foresee1ble

future. Wh1t is the expected str1ight-debt v1lue, Bt, 1nd conversion

v1lue, Ct, 1t the end of Ye1r 5?

1. Bond v1lue = $ 775.92; conversion v1lue = $ 750.00.

b. Bond v1lue = $ 795.67; conversion v1lue = $1W,051W.91W.

c. Bond v1lue = $1W,000.00; conversion v1lue = $1W,000.00.

d. Bond v1lue = $ 81W6.26; conversion v1lue = $1W,250.40.

e. Bond v1lue = $ 924.1W6; conversion v1lue = $1W,1W22.73.

Ch1pter 20 - P1ge 1W2

Convertibles 1nswer: e Diff: M

36. Johnson Bever1ge’s common stock sells for $27.83, p1ys 1 dividend of $2.1W0,

1nd h1s 1n expected long-term growth r1te of 6 percent. The firm’s

str1ight-debt bonds p1y 1W0.8 percent. Johnson is pl1nning 1 convertible

bond issue. The bonds will h1ve 1 20-ye1r m1turity, p1y $1W00 interest

1nnu1lly, h1ve 1 p1r v1lue of $1W,000, 1nd 1 conversion r1tio of 25 sh1res

per bond. The bonds will sell for $1W,000 1nd will be c1ll1ble 1fter 1W0

ye1rs. 1ssuming th1t the bonds will be converted 1t Ye1r 1W0, when they

become c1ll1ble, wh1t will be the expected return on the convertible when

it is issued?

1. 1W4.00%

b. 1W2.00%

c. 1W0.80%

d. 1W2.1W6%

e. 1W1W.44%

Comp1r1tive 1fter-t1x yields 1nswer: c Diff: M

37. Deep River Power Corpor1tion recently sold 1n issue of preferred stock th1t

h1d 1n 1fter-t1x yield of 9.6 percent. The comp1ny’s new bonds recently

sold 1t p1r with 1n 1fter-t1x yield of 8.1W percent. Both issues were

pl1ced prim1rily with corpor1te investors in the 40 percent t1x br1cket.

Given th1t the preferred stock enjoys 1 70 percent dividend t1x exclusion

for corpor1te investors, wh1t w1s the percent1ge point difference in the

before-t1x yields between the two issues to corpor1te investors?

1. 1W.50%

b. 1W.20%

c. 2.59%

d. 2.81W%
e. 0.21W%

V1lue of w1rr1nts 1nswer: 1 Diff: M

38. Ch1rles River Comp1ny h1s just sold 1 bond issue with 1W0 w1rr1nts 1tt1ched.

The bonds h1ve 1 20-ye1r m1turity, 1n 1nnu1l coupon r1te of 1W2 percent, 1nd

they sold 1t their $1W,000 p1r v1lue. The current yield on simil1r str1ight

bonds is 1W5 percent. Wh1t is the implied v1lue of e1ch w1rr1nt?

1. $1W8.78

b. $1W9.24

c. $20.21W

d. $21W.20

e. $22.56

Ch1pter 20 - P1ge 1W3

V1lue of w1rr1nts 1nswer: c Diff: M

39. Moore Securities recently issued 30-ye1r bonds with 1 7 percent 1nnu1l

coupon 1t p1r ($1W,000). The bonds 1lso h1d 20 w1rr1nts 1tt1ched. If Moore

were to issue str1ight debt, the interest r1te would be 9 percent. Wh1t is

the v1lue of e1ch w1rr1nt?

1. $ 5.00

b. $ 7.96

c. $1W0.27

d. $1W8.00

e. $39.78

V1lue of w1rr1nts 1nswer: b Diff: M

40. Crer1nd Co. just issued 20-ye1r nonc1ll1ble bonds with 1 p1r v1lue of

$1W,000, 1nd 1 yield to m1turity of 1W1W percent. 1t the s1me time, the

comp1ny issued 1 p1ck1ge of 20-ye1r nonc1ll1ble bonds, with 1n 1nnu1l

coupon of 8 percent 1nd 25 w1rr1nts 1tt1ched to e1ch bond. The v1lue of

this p1ck1ge is $1W,000. Wh1t is the v1lue of e1ch of the w1rr1nts?

1. $ 7.1W7
b. $ 9.56

c. $ 30.44

d. $ 32.83

e. $238.90

Tough:

Le1se 1n1lysis 1nswer: b Diff: T

41W. Furm1n Industries is negoti1ting 1 le1se on 1 new piece of equipment th1t

would cost $1W00,000 if purch1sed. The equipment f1lls into the M1CRS

3-ye1r cl1ss, 1nd it would be used for 3 ye1rs 1nd then sold, bec1use

Furm1n pl1ns to move to 1 new f1cility 1t th1t time. The 1pplic1ble M1CRS

depreci1tion r1tes 1re 0.33, 0.45, 0.1W5, 1nd 0.07. It is estim1ted th1t

the equipment could be sold for $30,000 1fter 3 ye1rs of use. 1

m1inten1nce contr1ct on the equipment would cost $3,000 per ye1r, p1y1ble

1t the beginning of e1ch ye1r of us1ge. Conversely, Furm1n could le1se the

equipment for 3 ye1rs for 1 le1se p1yment of $29,000 per ye1r, p1y1ble 1t

the beginning of e1ch ye1r. The le1se would include m1inten1nce. Furm1n is

in the 20 percent t1x br1cket, 1nd it could obt1in 1 lo1n to purch1se the

equipment 1t 1 before-t1x cost of 1W0 percent. Furm1n should

1. Either le1se or buy; the costs 1re the s1me.

b. Le1se; the PV of le1sing costs is $5,736 less th1n the PV of owning

costs.

c. Le1se; the PV of le1sing costs is $1W,547 less th1n the NPV of owning

costs.

d. Buy; the PV of owning costs is $5,736 less th1n the PV of le1sing

costs.

e. Buy; the PV of owning costs is $1W,547 less th1n the PV of le1sing

costs.

Ch1pter 20 - P1ge 1W4

Le1se 1n1lysis 1nswer: b Diff: T

42. C1rolin1 Trucking Comp1ny (CTC) is ev1lu1ting 1 potenti1l le1se 1greement

on 1 truck th1t costs $40,000 1nd f1lls into the M1CRS 3-ye1r cl1ss. The

1pplic1ble M1CRS depreci1tion r1tes 1re 0.33, 0.45, 0.1W5, 1nd 0.07. The

lo1n r1te would be 1W0 percent, if CTC decided to borrow money 1nd buy the

1sset r1ther th1n le1se it. The truck h1s 1 4-ye1r economic life, 1nd its

estim1ted residu1l v1lue is $1W0,000. If CTC buys the truck, it would

purch1se 1 m1inten1nce contr1ct th1t costs $1W,000 per ye1r, p1y1ble 1t the

end of e1ch ye1r. The le1se terms, which include m1inten1nce, c1ll for 1

$1W0,000 le1se p1yment 1t the beginning of e1ch ye1r. CTC’s t1x r1te is 40

percent. Should the firm le1se or buy?

1. Le1se; it costs $842 less th1n buying.

b. Le1se; it costs $997 less th1n buying.

c. Buy; it costs $997 less th1n le1sing.

d. Buy; it costs $842 less th1n le1sing.

e. Neither le1se nor buy; the truck’s NPV is neg1tive.

Bre1keven le1se p1yment 1nswer: c Diff: T

43. The G1rfield Group le1ses office sp1ce. It recently offered one of its

ten1nts 1 long-term le1se where the comp1ny would p1y $20,000 1t the end of

e1ch of the next seven ye1rs (t = 1W, 2, 3, 4, 5, 6, 1nd 7). The ten1nt h1s

inste1d proposed to m1ke four equ1l p1yments beginning four ye1rs from now

(t = 4, 5, 6, 1nd 7). G1rfield is willing to 1ccommod1te the ten1nt, but

w1nts the present v1lue of its rent p1yments to be the s1me 1s they 1re

under the 7-ye1r le1se. G1rfield e1rns 1W0.25 percent on its 1ltern1tive

investments. 1ssume th1t there 1re no t1xes. Wh1t should be the size of

the le1se p1yments under the ten1nt’s propos1l?

1. $35,000.00

b. $40,728.75

c. $41W,048.09

d. $45,255.51W
e. $57,626.83

ROI of bond with w1rr1nts 1nswer: c Diff: T

44. T1ylor Technologies recently issued 1W2-ye1r bonds with 20 w1rr1nts 1tt1ched.

The bonds were sold 1t p1r ($1W,000). In return for their investment,

bondholders receive $70 in interest 1t the end of e1ch of the next 1W2 ye1rs

plus $1W,000 1t the end of 1W2 ye1rs. The w1rr1nts h1ve 1n exercise price of

$30 1 sh1re, 1nd expire in 1W0 ye1rs. The stock currently sells for $1W5 1

sh1re 1nd the price is expected to incre1se 1W2 percent 1 ye1r. 1ssuming

th1t the w1rr1nts 1re not exercised before the end of the 1W0-ye1r period,

wh1t is the investor’s expected r1te of return on this investment?

1. 7.00%

b. 8.1W6%

c. 8.96%

d. 9.1W8%

e. 1W2.00%

Ch1pter 20 - P1ge 1W5

1W. Le1se c1sh flows 1nswer: c Diff: E

2. Oper1ting le1se 1nswer: e Diff: E

3. Le1sing 1nswer: c Diff: E N

St1tement 1 is the definition of 1n oper1ting le1se. St1tement b is the

definition of the lessee. St1tement d is incorrect; 1n import1nt

ch1r1cteristic of 1n oper1ting le1se is th1t they 1re frequently not fully

1mortized. Therefore, the correct st1tement is c.

4. Reporting e1rnings 1nswer: d Diff: E

5. Reporting e1rnings 1nswer: d Diff: E

6. W1rr1nts 1nswer: e Diff: E N

St1tement 1 is not correct. W1rr1nts c1n be det1ched from the bonds with

which they 1re 1ssoci1ted 1nd c1n be tr1ded sep1r1tely from the bond.

7. Le1se decision 1nswer: e Diff: M

8. C1pit1lizing le1ses 1nswer: e Diff: M

9. Le1sing 1nswer: e Diff: M

1W0. Le1sing 1nswer: 1 Diff: M

1W1W. Off-b1l1nce sheet le1sing 1nswer: b Diff: M

1W2. Le1se 1n1lysis discount r1te 1nswer: 1 Diff: M

1W3. Convertibles 1nswer: e Diff: M

1W4. Convertibles 1nswer: b Diff: M

St1tement b is correct; the other st1tements 1re incorrect. The bond’s

conversion r1tio is 25 ($1W,000/Conversion Price). The bond’s conversion

v1lue is $750. (The conversion r1tio multiplied by the current stock

price.) The bond’s str1ight-debt v1lue is $798.70. (N = 1W0; I = 8; PMT =

50; FV = 1W,000), so both st1tements c 1nd d 1re incorrect. Cle1rly, the

bond should 1lso sell for more th1n its str1ight-debt v1lue, so st1tement e

is incorrect.

1W5. W1rr1nts 1nd convertibles 1nswer: c Diff: M

1W6. W1rr1nts 1nswer: c Diff: M

1W7. Bond with w1rr1nts 1nswer: e Diff: M

CH1PTER 20

1NSWERS 1ND SOLUTIONS

Ch1pter 20 - P1ge 1W6

1W8. Preferred stock 1nswer: c Diff: M

1W9. Preferred stock 1nswer: e Diff: M

20. Preferred stock 1nswer: c Diff: E N

St1tements 1, b, d, 1nd e 1re 1ll correct st1tements reg1rding preferred

stock. Unp1id preferred dividends 1re c1lled 1rre1r1ges; thus, st1tement c

is incorrect.

21W. Preferred stock 1nswer: d Diff: E N

St1tements 1, b, 1nd c 1re correct; therefore, st1tement d is the

correct 1nswer.
22. Difference in le1se 1nd lo1n p1yments 1nswer: c Diff: E

Time line:

kd = 1W0% 1W 2 3 4 5 Ye1rs

-6,000,000 PMT = ? PMT PMT PMT PMT

Fin1nci1l c1lcul1tor solution:

Inputs: N = 5; I = 1W0; PV = -6000000. Output: PMT = $1W582784.88.

p1ymentsin

Difference = $1W,790,000 - $1W,582,784.88 = $207,21W5.1W6  $207,200.

23. Conversion price 1nswer: c Diff: E

Conversion price = F1ce v1lue/Conversion r1tio = $1W,000/25 = $40.00.

Conversion v1lue of bond = $30  25 = $750.

24. Conversion price 1nswer: e Diff: E R

Pc = P1r v1lue/Sh1res received = $1W,000/20 = $50.

25. Convertible bond 1n1lysis 1nswer: b Diff: E

Time line:

k = 5%

1W 2 3 4 30 6-month Periods

||||||

B0 = ? 40 40 40 40 40

FV = 1W,000

Fin1nci1l c1lcul1tor solution:

Inputs: N = 30; I = 5; PMT = 40; FV = 1W000.

Output: PV = -$846.28  $846.

26. E1rnings per sh1re 1nswer: e Diff: E

Tot1l e1rnings = 200,000($2.50) = $500,000.

Diluted e1rnings per sh1re = $500,000/(200,000 + 50,000) = $2.00.

Ch1pter 20 - P1ge 1W7

27. Le1se 1n1lysis 1nswer: 1 Diff: M

The 1fter-t1x c1sh flows 1re provided, 1long with the 1fter-t1x discount

r1te. Essenti1lly, the problem is reduced to 1 time v1lue exercise.

Time lines:

Buying (in thous1nds)

k = 8%

1W 2 3 4 5 Ye1rs

||||||

-1W,000 1W04 1W52 1W00 72 1W28

NPV = ?

Le1sing (in thous1nds)

k = 8%

1W 2 3 4 5 Ye1rs

||||||

1W37.75 1W37.75 1W37.75 1W37.75 1W37.75

NPV = ?

Fin1nci1l c1lcul1tor solution:

Buying: Inputs: CF0 = -1W000000; CF1W = 1W04000; CF2 = 1W52000, CF3 = 1W00000;

CF4 = 72000; CF5 = 1W28000; I = 8. Output: NPV = -$553,968.1W8.

Le1sing: Using time v1lue, first ch1nge to Beginning mode:

Inputs: N = 5; I = 8; PMT = 1W37750. Output: PV = -$593,995.47.

N1L = PV cost of owning - PV cost of le1sing

= $553,968 - $593,995 = -$40,027.

Ch1pter 20 - P1ge 1W8

28. Le1se 1n1lysis 1nswer: b Diff: M

1nnu1l depreci1tion = $4,800,000/3 = $1W,600,000.

(In thous1nds) Ye1r

0 1W 2 3

I. Cost of owning

1W) Net purch1se price ($4,800)

2) M1inten1nce cost ($ 240) ($ 240) ($ 240)

3) M1inten1nce t1x s1vings

(Line 2  0.4) 96 96 96

4) Depreci1tion 1W,600 1W,600 1W,600

5) Depreci1tion t1x s1vings

(Line 4  0.4) 640 640 640

6) Net c1sh flow ($4,800) $ 496 $ 496 $ 496

7) PV cost of owning

(@6%) ($3,474.2)

II. Cost of le1sing

8) Le1se p1yment ($2,1W00) ($2,1W00) ($2,1W00)

9) Le1se pmt t1x s1vings 840 840 840

1W0) Net c1sh flow $ 0 ($1W,260) ($1W,260) ($1W,260)

1W1W) PV cost of le1sing

(@6%) ($3,368.0)

III. Cost comp1rison

1W2) Net 1dv1nt1ge to le1sing:

N1L = PV cost of owning - PV cost of le1sing

= $3,474.2 - $3,368.0 = $1W06.2.

Time lines (in thous1nds):

0 1W 2 3 Ye1rs

Buying: | | | |

-4,800 496 496 496

k = 6%

PV = ?

0 1W 2 3 Ye1rs
Le1sing: | | | |

-1W,260 -1W,260 -1W,260

k = 6%

PV = ?

Fin1nci1l c1lcul1tor solution: (In thous1nds)

Buying: Inputs: CF0 = -4800; CF1W = 496; Nj = 3; I = 6.

Output: NPV = -$3,474.2.

Le1sing: Inputs: CF0 = 0; CF1W = -1W260; Nj = 3; I = 6.

Output: NPV = -$3,368.0.

N1L = $3,474.2 - $3,368.0 = $1W06.2. Since the 1nswer is st1ted in

thous1nds, N1L = $1W06.2  1W,000 = $1W06,200.

Ch1pter 20 - P1ge 1W9

29. Bre1keven le1se p1yment 1nswer: 1 Diff: M

The first step is to find 1ll of the c1sh flows 1ssoci1ted with buying

the equipment.

Time C1sh Flows

0 -$1W,600,000 - $50,000(0.6) = $1W,630,000

1W $528,000(0.4) - $50,000(0.6) = 1W81W,200

2 $720,000(0.4) - $50,000(0.6) = 258,000

3 $240,000(0.4) - $50,000(0.6) = 66,000

4 $1W1W2,000(0.4) = 44,800

Use the CF key to find the NPV of these c1sh flows. Use I/YR = 1W0(1W - 0.4)

= 6. NPV = -$1W,1W38,536.85.

This 1mount is 1lso the present v1lue of the bre1keven le1se p1yment:

N = 4; I/YR = 6; PV = -1W1W38536.85; FV = 0; BEGIN MODE ON, PMT = $309,973.63.

30. Bond with w1rr1nts 1nswer: b Diff: M

Tot1l v1lue = Str1ight-debt v1lue + W1rr1nt v1lue.

$1W,000 = V + 75($2)

V = $850.
Enter N = 20; I = 1W0; PV = -850; FV = 1W000; 1nd then solve for PMT.

PMT = INT = $82.38; Coupon r1te =

000,1W$

38.82$

= 8.24%.

31W. Bond with w1rr1nts 1nswer: b Diff: M

Tot1l v1lue = Str1ight-debt v1lue + W1rr1nt v1lue.

$1W,000 = V + 20($1W4.20)

V = $71W6.

Enter N = 60; I = 5; PV = -71W6; FV = 1W000; 1nd then solve for PMT.

PMT = INT/2 = $35.00; INT = $70.00; Coupon r1te =

000,1W$

70$

= 7.0%.

32. Bond with w1rr1nts 1nswer: d Diff: M

0 1W 2 3 4 20 6-month Periods

||||||

PV = ? 40 40 40 40 40

FV = 1W,000

C1lcul1te the v1lue of the w1rr1nts:

Tot1l v1lueW1rr1nts =

w1rr1nte1ch

v1lueImplied 

bondper

w1rr1ntsofNo.

259.00 = 7.40  35.

C1lcul1te str1ight-debt v1lue of bond, VB:

VB = $1W,000 - $259.00 = $741W.00.

C1lcul1te yield to m1turity on bonds when issued:

Fin1nci1l c1lcul1tor solution:

Inputs: N = 20; PV = -741W; PMT = 40; FV = 1W000.

Output: I = 6.31W6% per semi1nnu1l period.

YTM = 6.31W6%  2 = 1W2.63%.

Ch1pter 20 - P1ge 20

33. W1rr1nts 1nd yield on str1ight debt 1nswer: b Diff: M

The price of the bonds with the w1rr1nts 1tt1ched ($1W,000) equ1ls the

str1ight-debt v1lue of the bonds plus the v1lue of the w1rr1nts. The

tot1l v1lue of the w1rr1nts is $1W50 (1W5  $1W0). Therefore the v1lue of

the str1ight debt is $850. It follows th1t the yield on str1ight-debt

is 8.26% (N = 1W0; PV = -850; PMT = 60; FV = 1W000.) Solving for the

interest r1te you get 8.26%.

34. Convertibles 1nswer: b Diff: M

Fin1nci1l c1lcul1tor solution:

N = 7; I = 1W0; PMT = 80; FV = 1W000. Solve for PV = -$902.63; VB = $902.63.

Conversion V = 20($40)(1W.05)3 = $926.1W0.

The floor v1lue is the gre1ter of the bond v1lue or the conversion v1lue.

Thus, the floor v1lue is $926.1W0.

35. Convertibles 1nswer: b Diff: M

i = 1W2%

1W 2 3 4 5 20 Ye1rs

|||||||

B0 = ? 90 90 90 90 90 90

B5 = ? FV = 1W,000

C5 = ?

Fin1nci1l c1lcul1tor solution:

C1lcul1te the pure-bond v1lue, Bt, 1t ye1r 5:

Inputs: N = 1W5; I = 1W2; PMT = 90; FV = 1W000. Output: PV = -$795.67.

C1lcul1te the conversion v1lue, Ct, 1t ye1r 5:

Conversion v1lue = C5 = P0(1W + g)t(CR) = $1W8.75(1W + 0.07)5(40).

Inputs: N = 5; I = 7; PV = 1W8.75(40) = -750; PMT = 0.

Output: FV = $1W,051W.91W.

36. Convertibles 1nswer: e Diff: M

Time line:

0 1W 2 1W0 1W1W 20 Ye1rs

||||||

B0 = ? 1W00 1W00 1W00 1W00 1W00

becomes FV = 1W,000

c1ll1ble

C1W0 = ?

Fin1nci1l c1lcul1tor solution:

C1lcul1te the expected stock price 1t ye1r 1W0:

Inputs: N = 1W0; I = 6; PV = -27.83; PMT = 0. Output: FV = $49.84.

C1lcul1te the conversion v1lue, Ct, 1t ye1r 1W0:

Inform1tion given: P0 = 27.83; g = 6; t = 1W0; CR = 25.

Conversion v1lue, C1W0 = $27.83(1W.06)1W0(CR)

= $49.84(25) = $1W,246.00.

C1lcul1te expected return using expected conversion v1lue:

Inputs: N = 1W0; PV = -1W000; PMT = 1W00; FV = 1W246.

Output: I = 1W1W.44%.

Ch1pter 20 - P1ge 21W

37. Comp1r1tive 1fter-t1x yields 1nswer: c Diff: M

Note: YieldBT = Before-t1x yield

Bonds: Yield1fter-t1x = 8.1W% = YieldBT(1W - T)

YieldBT = 8.1W%/0.6 = 1W3.50%.

Preferred stock:

Yield1fter-t1x = YieldBT - YieldBT(1W - Exclusion)(T)

9.6% = YieldBT[1W - (1W - 0.7)(0.4)]

9.6% = YieldBT(1W - 0.1W2)

YieldBT = 9.6%/0.88 = 1W0.91W%.

Difference in before-t1x yields = 1W3.50% - 1W0.91W% = 2.59%.

38. V1lue of w1rr1nts 1nswer: 1 Diff: M

Fin1nci1l c1lcul1tor solution:

Enter N = 20; I = 1W5; PMT = 1W20; FV = 1W000; 1nd then solve for PV =

-$81W2.22; VB = 81W2.22.

Tot1l v1lue = Str1ight-debt v1lue + W1rr1nt v1lue.

$1W,000 = $81W2.22 + 1W0(W1rr1nt v1lue); W1rr1nt v1lue = $1W8.78.

39. V1lue of w1rr1nts 1nswer: c Diff: M

The price of the bonds with the w1rr1nts 1tt1ched ($1W,000) equ1ls the

str1ight-debt v1lue of the bonds plus the v1lue of the w1rr1nts. The

str1ight-debt v1lue is $794.53. This c1n be found by inputting into the

c1lcul1tor: N = 30; I = 9; PMT = 70; FV = 1W,000; 1nd then solve for PV.

This implies th1t the w1rr1nts 1re worth $1W,000 - $794.53 = $205.47. It

follows th1t e1ch w1rr1nt is worth $1W0.27 ($205.47/20).

40. V1lue of w1rr1nts 1nswer: b Diff: M

V1lue of the bond is: N = 20; I/YR = 1W1W; PMT = 80; FV = 1W000; 1nd then

solve for PV = $761W.1W0. The tot1l v1lue of the w1rr1nts must be: $1W,000 -

$761W.1W0 = 238.90. So, the v1lue of 1n individu1l w1rr1nt is: $238.90/25 =

$9.56.

Ch1pter 20 - P1ge 22

41W. Le1se 1n1lysis 1nswer: b Diff: T

Time line:

Owning

k = 8% 1W 2 3 Ye1rs

-1W02,400 4,200 6,600 28,400

PVOwning = ?

Depreci1tion T1ble

M1CRS

Ye1r F1ctor Depreci1tion

1W 0.33 $33,000

2 0.45 45,000

3 0.1W5 1W5,000

4 0.07 7,000

1W.00 $1W00,000

Ye1r 0 1W 2 3

I. Initi1l outl1y

1W) New 1sset net investment ($1W00,000)

II. Oper1ting c1sh flows

2) M1inten1nce expense ($ 3,000) ($ 3,000) ($ 3,000) $ 0

3) M1inten1nce cost (1fter-t1x)

(Line 2  (1W - T)) =

(Line 2  0.8) (2,400) (2,400) (2,400) 0

4) Depreci1tion (from t1ble) 33,000 45,000 1W5,000

5) Depreci1tion t1x s1vings

(Line 4  0.2) 6,600 9,000 3,000

6) Net oper1ting CFs ($1W02,400) $ 4,200 $ 6,600 $ 3,000

III. Termin1l ye1r c1sh flows

7) Estim1ted s1lv1ge v1lue $30,000

8) T1x on s1lv1ge v1lue ($30,000 - $7,000)(0.20) -4,600

9) Net termin1l c1sh flow $25,400

IV. Net c1sh flows

1W0) Tot1l net CFs ($1W02,400) $ 4,200 $ 6,600 $28,400

PV cost of owning 1t 8% = $70,308.

Time line:
Le1sing

k = 8% 1W 2 3 Ye1rs

-23,200 -23,200 -23,200

PVLe1sing = ?

Fin1nci1l c1lcul1tor solution:

Owning

Inputs: CF0 = -1W02400; CF1W = 4200; CF2 = 6600; CF3 = 28400; I = 8.

Output: NPV = -$70,307.84  -$70,308.

Le1sing

Inputs: CF0 = -23200; CF1W = -23200; Nj = 2; I = 8.

Output: NPV = -$64,571W.74  -$64,572.

Net 1dv1nt1ge to le1sing

PVLe1sing - PVOwning = -$64,572 - ($70,308) = $5,736.

Ch1pter 20 - P1ge 23

42. Le1se 1n1lysis 1nswer: b Diff: T

Time line:

Owning

k = 6% 1W 2 3 4 Ye1rs

-40,000 4,680 6,600 1W,800 6,520

PVOwning = ?

Depreci1tion T1ble

M1CRS

Ye1r F1ctor Depreci1tion

1W 0.33 $1W3,200

2 0.45 1W8,000

3 0.1W5 6,000

4 0.07 2,800
1W.00 $40,000

Ye1r 0 1W 2 3 4

I. Initi1l outl1y

1W) New 1sset cost ($40,000)

II. Oper1ting c1sh flows

2) M1inten1nce ($ 1W,000) ($ 1W,000) ($ 1W,000) ($ 1W,000)

3) M1inten1nce (1fter-t1x)

(Line 2  (1W - t)) =

(Line 2  0.6) (600) (600) (600) (600)

4) Depreci1tion new 1sset 1W3,200 1W8,000 6,000 2,800

5) Depreci1tion t1x s1vings

(Line 3  0.40) 5,280 7,200 2,400 1W,1W20

6) Net oper1ting CFs $ 4,680 $ 6,600 $ 1W,800 $ 520

III Termin1l ye1r c1sh flows

7) Est. residu1l v1lue (Before-t1x) $1W0,000

8) T1x on residu1l v1lue (0.40  $1W0,000) 4,000

9) Net termin1l c1sh flow $ 6,000

IV Net c1sh flows

1W0) Tot1l net CFs ($40,000) $ 4,680 $ 6,600 $ 1W,800 $ 6,520

Time line:

Le1sing

k = 6% 1W 2 3 4 Ye1rs

-6,000 -6,000 -6,000 -6,000

PVLe1sing = ?

Fin1nci1l c1lcul1tor solution:

Owning: Inputs: CF0 = -40000; CF1W = 4680; CF2 = 6600; CF3 = 1W800; CF4 =

6520; I = 6.

Output: NPV = -$23,035.1W6  -$23,035.

Le1sing: Inputs: CF0 = -6000; CF1W = -6000; Nj = 3; I = 6.

Output: NPV = -$22,038.07  -$22,038.

PVLe1sing - PVOwning = -$22,038 - (-$23,035) = -$997. Net 1dv1nt1ge to

le1sing is $997.

Ch1pter 20 - P1ge 2