Question 1

A convertible debenture can never sell for more than its conversion value or less than its bond value.

Accepted Answer

A) True 
 B)False

Question 2

Curran Contracting is issuing new 25-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 implied value of each warrant?

Accepted Answer

A)  $8.00 
B)  $8.42 
C)  $8.84 
D)  $9.28 
E)  $9.75 
A)  $8.00 
B)  $8.42 
C)  $8.84 
D)  $9.28 
E)  $9.75

Question 3

Curry Corporation is setting the terms on a new issue of bonds with warrants. The bonds will have a 30-year maturity and annual interest payments. Each bond will come with 20 warrants that give the holder the right to purchase one share of stock per warrant. The investment bankers estimate that each warrant will have a value of $10.00. A similar straight-debt issue would require a 10% coupon. What coupon rate should be set on the bonds-with-warrants so that the package would sell for $1,000?

Accepted Answer

A)  6.75% 
B)  7.11% 
C)  7.48% 
D)  7.88% 
E)  8.27% 
A)  6.75% 
B)  7.11% 
C)  7.48% 
D)  7.88% 
E)  8.27%

Question 4

Warren Corporation's stock sells for $42 per share. The company wants to sell some 20-year, annual interest, $1,000 par value bonds. Each bond would have 75 warrants attached to it, each exercisable into one share of stock at an exercise price of $47. The firm's straight bonds yield 10%. Each warrant is expected to have a market value of $2.00 given that the stock sells for $42. What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par?

Accepted Answer

A)  7.83% 
B)  8.24% 
C)  8.65% 
D)  9.08% 
E)  9.54% 
A)  7.83% 
B)  8.24% 
C)  8.65% 
D)  9.08% 
E)  9.54%

Question 5

Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.

Accepted Answer

A) True 
 B)False

Question 6

Assume that a piece of leased equipment has a relatively high expected residual value. From the lessee's viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate.

Accepted Answer

A) True 
 B)False

Question 7

Valdes Enterprises is considering issuing a 10-year convertible bond that would be priced at its $1,000 par value. The bonds would have an 8.00% annual coupon, and each bond could be converted into 20 shares of common stock. The required rate of return on an otherwise similar nonconvertible bond is 10.00%. The stock currently sells for $40.00 a share, has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 5.00%. What is the estimated floor price of the convertible at the end of Year 4?

Accepted Answer

A)  $901.28 
B)  $924.39 
C)  $948.09 
D)  $972.41 
E)  $996.72 
A)  $901.28 
B)  $924.39 
C)  $948.09 
D)  $972.41 
E)  $996.72

Question 8

Bev's Beverages is negotiating a lease on a new piece of equipment that would cost $80,000 if purchased. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 3 years is $25,000. A maintenance contract on the equipment would cost $2,500 per year, payable at the beginning of each year. Alternatively, the firm could lease the equipment for 3 years for a lease payment of $23,000 per year, payable at the beginning of each year. The lease would include maintenance. The firm is in the 20% tax bracket, and it could obtain a 3-year simple interest loan, interest payable at the end of the year, to purchase the equipment at a before-tax cost of 8%. If there is a positive Net Advantage to Leasing the firm will lease the equipment. Otherwise, it will buy it. What is the NAL? (Note: MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.)

Accepted Answer

A)  $2,852 
B)  $2,994 
C)  $3,144 
D)  $3,301 
E)  $3,466 
A)  $2,852 
B)  $2,994 
C)  $3,144 
D)  $3,301 
E)  $3,466

Question 9

Ballentine Inc., which has a zero tax rate due to tax loss carry-forwards, is considering a 6-year, $5,000,000 bank loan in order to buy a new piece of equipment. The loan will be amortized over 6 years with end-of-year payments and has an interest rate of 9%. Alternatively, Ballentine can also lease the equipment for an end-of-year payment of $1,250,000. By how much does the lease payment exceed the loan payment?

Accepted Answer

A)  $110,285 
B)  $116,090 
C)  $122,199 
D)  $128,631 
E)  $135,401 
A)  $110,285 
B)  $116,090 
C)  $122,199 
D)  $128,631 
E)  $135,401

Question 10

Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.

Accepted Answer

A) True 
 B)False

Question 11

Emerson Electrical Engineering Inc. is issuing new 20-year bonds that have warrants attached. If not for the attached warrants, the bonds would carry an 11% interest rate. However, with the warrants attached the bonds will pay a 9% annual coupon. There are 25 warrants attached to each bond, which have a par value of $1,000. The exercise price of the warrants is $25.00 and the expected stock price 10 years from now (when the warrants may be exercised) is $50.77. What is the investor's expected overall pre-tax rate of return for this bond-with-warrants issue?

Accepted Answer

A)  10.64% 
B)  11.20% 
C)  11.79% 
D)  12.38% 
E)  13.00% 
A)  10.64% 
B)  11.20% 
C)  11.79% 
D)  12.38% 
E)  13.00%

Question 12

Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price, and they also benefit from the 70% tax exemption on preferred dividends received.

Accepted Answer

A) True 
 B)False

Question 13

Which of the following statements is most CORRECT?

Accepted Answer

A)  Warrants have an option feature but convertibles do not. 
B)  One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds. 
C)  The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt. 
D)  The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant. 
E)  Warrants can sometimes be detached and traded separately from the security with which they were issued, but this is unusual. 
A)  Warrants have an option feature but convertibles do not. 
B)  One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds. 
C)  The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt. 
D)  The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant. 
E)  Warrants can sometimes be detached and traded separately from the security with which they were issued, but this is unusual.

Question 14

The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants are used.

Accepted Answer

A) True 
 B)False

Question 15

Heavy use of off-balance-sheet lease financing will tend to

Accepted Answer

A)  make a company appear more risky than it actually is because its stated debt ratio will be increased. 
B)  make a company appear less risky than it actually is because its stated debt ratio will appear lower. 
C)  affect a company's cash flows but not its degree of risk. 
D)  have no effect on either cash flows or risk because the cash flows are already reflected in the income statement. 
E)  affect the lessee's cash flows but only due to tax effects. 
A)  make a company appear more risky than it actually is because its stated debt ratio will be increased. 
B)  make a company appear less risky than it actually is because its stated debt ratio will appear lower. 
C)  affect a company's cash flows but not its degree of risk. 
D)  have no effect on either cash flows or risk because the cash flows are already reflected in the income statement. 
E)  affect the lessee's cash flows but only due to tax effects.

Question 16

Its investment bankers have told Donner Corporation that it can issue a 25-year, 8.1% annual payment bond at par. They also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 40% tax bracket. The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 1.0%, which would represent an after-tax risk premium. What coupon rate must be set on the preferred in order to issue it at par?

Accepted Answer

A)  6.66% 
B)  6.99% 
C)  7.34% 
D)  7.71% 
E)  8.09% 
A)  6.66% 
B)  6.99% 
C)  7.34% 
D)  7.71% 
E)  8.09%

Question 17

What is the bond's straight-debt value at the time of issue?

Accepted Answer

A)  $684.78 
B)  $720.82 
C)  $758.76 
D)  $798.70 
E)  $838.63 
A)  $684.78 
B)  $720.82 
C)  $758.76 
D)  $798.70 
E)  $838.63

Question 18

The owner of a convertible bond owns, in effect, both a bond and a call option.

Accepted Answer

A) True 
 B)False

Question 19

Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.

Accepted Answer

A) True 
 B)False

Question 20

Which of the following statements is most CORRECT?

Accepted Answer

A)  Preferred stock generally has a higher component cost of capital to the firm than does common stock. 
B)  By law in most states, all preferred stock must be cumulative, meaning that the compounded total of all unpaid preferred dividends must be paid before any dividends can be paid on the firm's common stock. 
C)  From the issuer's point of view, preferred stock is less risky than bonds. 
D)  Whereas common stock has an indefinite life, preferred stocks always have a specific maturity date, generally 25 years or less. 
E)  Unlike bonds, preferred stock cannot have a convertible feature. 
A)  Preferred stock generally has a higher component cost of capital to the firm than does common stock. 
B)  By law in most states, all preferred stock must be cumulative, meaning that the compounded total of all unpaid preferred dividends must be paid before any dividends can be paid on the firm's common stock. 
C)  From the issuer's point of view, preferred stock is less risky than bonds. 
D)  Whereas common stock has an indefinite life, preferred stocks always have a specific maturity date, generally 25 years or less. 
E)  Unlike bonds, preferred stock cannot have a convertible feature.

A convertible debenture can never sell for more than its conversion value or less than its bond value.

Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.

Assume that a piece of leased equipment has a relatively high expected residual value. From the lessee's viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate.

Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.

Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price, and they also benefit from the 70% tax exemption on preferred dividends received.

Which of the following statements is most CORRECT?

The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants are used.

Heavy use of off-balance-sheet lease financing will tend to

What is the bond's straight-debt value at the time of issue?

The owner of a convertible bond owns, in effect, both a bond and a call option.

Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.

Which of the following statements is most CORRECT?

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Exam 20: Hybrid Financing

A convertible debenture can never sell for more than its conversion value or less than its bond value.

Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.

Assume that a piece of leased equipment has a relatively high expected residual value. From the lessee's viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate.

Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.

Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price, and they also benefit from the 70% tax exemption on preferred dividends received.

Which of the following statements is most CORRECT?

The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants are used.

Heavy use of off-balance-sheet lease financing will tend to

What is the bond's straight-debt value at the time of issue?

The owner of a convertible bond owns, in effect, both a bond and a call option.

Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.

Which of the following statements is most CORRECT?

Overview

Financial Markets

Financial Statements

Statement Analysis

Time Value of Money

Forecasting

Interest Rates

Risk and Return

Bonds

Stocks

Cost of Capital

Capital Budgeting Mc Problems

Cash Flow and Risk

Real Options

Capital Structure

Dividends

Working Capital

Derivatives

Multinational

Mergers

Filters