Exam 20: Hybrid Financing

Preferred stockholders have priority over common stockholders with respect to dividends, because dividends must be paid on preferred stock before they can be paid on common stock. However, preferred and common stockholders normally have equal priority with respect to liquidating proceeds in the event of bankruptcy.

Which of the following statements about convertibles is most CORRECT?

Operating leases help to shift the risk of obsolescence from the user to the lessor.

Sutton Corporation, which has a zero tax rate due to tax loss carry-forwards, is considering a 5-year, $6,000,000 bank loan to finance service equipment. The loan has an interest rate of 10% and would be amortized over 5 years, with 5 end-of-year payments. Sutton can also lease the equipment for 5 end-of-year payments of $1,790,000 each. How much larger or smaller is the bank loan payment than the lease payment? Note: Subtract the loan payment from the lease payment.

Cannon Manufacturing is considering issuing 15-year, 8% annual coupon, $1,000 face value convertible bonds at a price of $1,000 each. Each bond would be convertible into 25 shares of common stock. If the bonds were not convertible, investors would require an annual yield of 10%. The stock's current price is $25.00, its expected dividend is $2.50, and its expected growth rate is 5%. The bonds are noncallable for 10 years. What is the bond's conversion value in Year 5?

Thomson Engineering is issuing new 20-year bonds that have warrants attached. If not for the attached warrants, the bonds would carry an 11% annual interest rate. However, with the warrants attached the bonds will pay an 8% annual coupon. There are 30 warrants attached to each bond, which have a par value of $1,000. What is the value of the straight-debt portion of the bonds?

A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock.

In the lease-versus-buy decision, leasing is often preferable

What is the bond's initial conversion value when issued?

Operating leases often have terms that include

Firms generally do not call their convertibles unless the conversion value is greater than the call price.

Chocolate Factory's convertible debentures were issued at their $1,000 par value in 2011. At any time prior to maturity on February 1, 2031, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?

Based on your

Carolina Trucking Company (CTC) is evaluating a potential lease for a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 9%, and the loan would be amortized over the truck's 4-year life. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $12,000. If CTC buys the truck, it would purchase a maintenance contract that costs $1,500 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year. CTC's tax rate is 35%. What is the net advantage to leasing? (Note: MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.)

A detachable warrant is a warrant that can be removed from the security with which it was issued and traded separately from it. Most traded warrants are originally attached to bonds or preferred stocks.

A lease-versus-purchase analysis should compare the cost of leasing to the cost of owning, assuming that the asset purchased

Moniker Manufacturing's bonds were recently issued at their $1,000 par value. At any time prior to maturity (20 years from now), a bondholder can exchange a bond for a share of common stock at a conversion price of $40. What is the conversion ratio?

Atlas Anglers Inc. is considering issuing a 15-year convertible bond that will be priced at its $1,000 par value. The bonds have a 6.5% annual coupon rate, and each bond can be converted into 20 shares of common stock. The stock currently sells at $30 a share, has an expected dividend in the coming year of $3, and has an expected constant growth rate of 5.5%. What is the estimated floor price of the convertible at the end of Year 3 if the required rate of return on a similar straight-debt issue is 9.5%?

The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under IRS guidelines.

A warrant is an option, and as such it cannot be used as a "sweetener."