Professional Documents
Culture Documents
Data:
New computer costs $1,200,000.
3-year MACRS class life; 4-year economic life.
Tax rate = 40%.
rd = 10%.
Maintenance of $25,000/year, payable at
beginning of each year.
Residual value in Year 4 of $125,000.
4-year lease includes maintenance.
Lease payment is $340,000/year, payable at
beginning of each year.
20-3
Depreciation Schedule
20-4
In a lease analysis, at what discount
rate should cash flows be discounted?
20-5
Cost of Owning Analysis
0 1 2 3 4
Cost of asset -1,200.0
Deprec. tax savings 158.4 216.0 72.0 33.6
Maintenance (A-T) -15.0 -15.0 -15.0 -15.0
Residual value (A-T) 75.0
Net cash flow -1,215.0 143.4 201.0 57.0 108.6
20-6
Notes on Cost of Owning Analysis
20-7
Cost of Leasing Analysis
0 1 2 3 4
A-T Lease pmt -204 -204 -204 -204
20-8
Net Advantage of Leasing
20-9
What if there is a lot of uncertainty
about the computer’s residual value?
20-10
What if a cancellation clause were included in
the lease? How would this affect the riskiness
of the lease?
20-11
How does preferred stock differ
from common equity and debt?
Preferred dividends are fixed, but they may
be omitted without placing the firm in default.
Preferred dividends are cumulative up to a
limit.
Most preferred stocks prohibit the firm from
paying common dividends when the preferred
is in arrears.
20-12
What is adjustable-rate preferred?
20-13
How can a knowledge of call options help one
understand warrants and convertibles?
20-14
A Firm Wants to Issue a Bond with Warrants
Package at a Face Value of $1,000
20-15
What coupon rate should be set for this
bond plus warrants package?
20-16
Calculating Required Annual Coupon Rate for
Bond with Warrants Package
20-17
What is the expected rate of return to holders
of bonds with warrants, if exercised in 5 years
at P5 = $17.50?
20-18
Finding the Opportunity Cost of Capital
for the Bond with Warrants Package
0 1 4 5 6 19 20
... ...
+1,000 -110 -110 -110 -110 -110 -110
-250 -1,000
-360 -1,110
20-19
The Firm is Now Considering a Callable,
Convertible Bond Issue
20-20
What conversion price (Pc) is implied by
this bond issue?
20-21
What is the convertible’s straight-
debt value?
Recall that the straight-debt coupon rate is
12% and the bonds have 20 years until
maturity.
20-22
Implied Convertibility Value
20-23
What is the formula for the bond’s
expected conversion value in any year?
20-24
What is meant by the floor value of
a convertible?
The floor value is the higher of the straight-
debt value and the conversion value.
At t = 0, the floor value is $850.61.
Straight-debt value0 = $850.61. C0 = $800.
At t = 10, the floor value is $1,727.14.
Straight-debt value10 = $887.00. C10 = $1,727.14.
Convertibles usually sell above floor value
because convertibility has an additional value.
20-25
When is the issue expected to be
called?
The firm intends to force conversion when C =
1.2($1,000) = $1,200.
We are solving for the period of time until the
conversion value equals the call price. After this time,
the conversion value is expected to exceed the call
price.
20-26
What is the convertible’s expected cost of
capital to the firm, if converted in Year 5?
0 1 2 3 4 5
1,000 -100 -100 -100 -100 -100
-1,200
-1,300
20-27
Is the cost of the convertible consistent
with the riskiness of the issue?
20-28
Besides cost, what other factor should be
considered when using hybrid securities?
20-29
Other Issues Regarding the Use of
Hybrid Securities
Does the firm want to commit to 20 years of
debt?
Conversion removes debt, while the exercise of
warrants does not.
If stock price does not rise over time, then
neither warrants nor convertibles would be
exercised. Debt would remain outstanding.
20-30