Deck 9: Dividend Policy and Long-Term Debt and Leasing

Question 1

Choc-lattes Corp. earned $5.00 per share in 2006, and paid a dividend of $2.00 per share. If it earns $5.50 in 2007 and follows a constant nominal payout policy, its dividend will be

A) $3.30
B) $3.00
C) $2.20
D) $2.00

Answer 1

$2.00

Question 2

Choc-lattes Corp. earned $5.00 per share in 2006, and paid a dividend of $2.00 per share. If it earns $5.50 in 2007 and follows a constant payout ratio policy, its dividend will be

A) $3.30
B) $3.00
C) $2.20
D) $2.00

Answer 2

$2.20

Question 3

Loose Cannon Co.
Loose Cannon Co. is evaluating a new $75 million bond issue, the proceeds of which would be used to call and retire its outstanding $75 million bonds. Details on both bond issues are presented below. The firm is in the 35% tax bracket.
Old Bonds The old issue sold at par, with a coupon rate of 11 percent. It was issued five years ago with a twenty year maturity. The issue had $350,000 in flotation costs and carries a call price of $1150.
New Bonds The new issue are expected to sell at par with an 8.5 percent coupon rate and a 15 year maturity. Flotation costs are forecast to be $500,000. Interest payments will overlap for 2 months while the old bonds are retired.

-Refer to Loose Cannon Co. What is the initial investment required to refund the bonds?

A) $11,250,000
B) $8,614,375
C) $7,312,500
D) $3,937,500

Answer 3

$8,614,375

Question 4

Loose Cannon Co.
Loose Cannon Co. is evaluating a new $75 million bond issue, the proceeds of which would be used to call and retire its outstanding $75 million bonds. Details on both bond issues are presented below. The firm is in the 35% tax bracket.
Old Bonds The old issue sold at par, with a coupon rate of 11 percent. It was issued five years ago with a twenty year maturity. The issue had $350,000 in flotation costs and carries a call price of $1150.
New Bonds The new issue are expected to sell at par with an 8.5 percent coupon rate and a 15 year maturity. Flotation costs are forecast to be $500,000. Interest payments will overlap for 2 months while the old bonds are retired.

-Refer to Loose Cannon Co. What are the annual cash flows associated with the new bonds?

A) $4,143,750
B) $6,375,000
C) $4,132,083
D) $6,357,051

Question 5

Loose Cannon Co.
Loose Cannon Co. is evaluating a new $75 million bond issue, the proceeds of which would be used to call and retire its outstanding $75 million bonds. Details on both bond issues are presented below. The firm is in the 35% tax bracket.
Old Bonds The old issue sold at par, with a coupon rate of 11 percent. It was issued five years ago with a twenty year maturity. The issue had $350,000 in flotation costs and carries a call price of $1150.
New Bonds The new issue are expected to sell at par with an 8.5 percent coupon rate and a 15 year maturity. Flotation costs are forecast to be $500,000. Interest payments will overlap for 2 months while the old bonds are retired.

-Refer to Loose Cannon Co. What is the NPV of the refunding decision?

A) $3,654,164
B) $5,356,375
C) $1,224,292
D) $8,614,375

Question 6

Bear Lake Equipment Company (BLEC)
Bear Lake Equipment Company (BLEC) is considering an expansion which will require a new machine that costs $125,000. BLEC can either lease or buy the equipment. The company's tax rate is 40% and its after tax cost of debt is 5%.
Lease: Annual payments of $26,400 made at the beginning of each year over five years. The lessor covers all maintenance, while the lessee covers insurance and other costs. The lessee has the option to purchase the machine for $31,250 paid along with the final lease payment.
Purchase: The $125,000 cost will be financed over five years with annual end of year payments of $31,580. The machine will be depreciated on the five year MACRS schedule, and the firm will pay $3,500 per year for a service contract to cover all maintenance. The company will cover all insurance and other costs.

-Refer to BLEC. What is the after-tax cash flow per year for the lease?

A) $26,400
B) $15,840
C) $10,560
D) $39,600

Question 7

Bear Lake Equipment Company (BLEC)
Bear Lake Equipment Company (BLEC) is considering an expansion which will require a new machine that costs $125,000. BLEC can either lease or buy the equipment. The company's tax rate is 40% and its after tax cost of debt is 5%.
Lease: Annual payments of $26,400 made at the beginning of each year over five years. The lessor covers all maintenance, while the lessee covers insurance and other costs. The lessee has the option to purchase the machine for $31,250 paid along with the final lease payment.
Purchase: The $125,000 cost will be financed over five years with annual end of year payments of $31,580. The machine will be depreciated on the five year MACRS schedule, and the firm will pay $3,500 per year for a service contract to cover all maintenance. The company will cover all insurance and other costs.

-Refer to BLEC. What is the after tax cash flow for the first year from a purchase of the machine?

A) $31,583
B) $21,167
C) $19,515
D) $25,000

Question 8

If a 9%, $100,000 loan has a balance of $83,724 and an annual payment of $13,965 is to be made, what will the allocation of principal and interest be?

A) $9,000 interest, $4,965 principal
B) $7,535 interest, $6,430 principal
C) $6,430 interest, $7,535 principal
D) $4,965 interest, $9,000 principal

Question 9

Bavarian Brew Bond
Bavarian Brew is thinking about recalling $30 million of 15 year, $1,000 par value bonds, that were issued ten years ago. The bonds carry a coupon rate of 7.8% and have a call price of $1,110. Initially the bonds generated total proceeds of $28.65 million and the flotation costs were $500,000. Bavarian Brew wants to sell $30 million of 5 year, $1,000 par value bonds with a 5.8% coupon rate to retire the old bonds. The flotation costs on the new bond issue are estimated to be $525,000. Due to having to issue the new bonds before the old bonds can be retired the company expects a period of 3 months were they have to pay interest on the old and the new bonds. Assume a tax rate of 34%

-Refer to Bavarian Brew Bond. What is the after tax cost of the call premium?

A) $3,300,000
B) $1,122,000
C) $2,178,000
D) $2,867,000

Question 10

Bavarian Brew Bond
Bavarian Brew is thinking about recalling $30 million of 15 year, $1,000 par value bonds, that were issued ten years ago. The bonds carry a coupon rate of 7.8% and have a call price of $1,110. Initially the bonds generated total proceeds of $28.65 million and the flotation costs were $500,000. Bavarian Brew wants to sell $30 million of 5 year, $1,000 par value bonds with a 5.8% coupon rate to retire the old bonds. The flotation costs on the new bond issue are estimated to be $525,000. Due to having to issue the new bonds before the old bonds can be retired the company expects a period of 3 months were they have to pay interest on the old and the new bonds. Assume a tax rate of 34%

-Refer to Bavarian Brew Bond. What is the tax reduction caused by the unamortized flotation costs?

A) $500,000
B) $333,333
C) $56,667
D) $256,472

Question 11

Bavarian Brew Bond
Bavarian Brew is thinking about recalling $30 million of 15 year, $1,000 par value bonds, that were issued ten years ago. The bonds carry a coupon rate of 7.8% and have a call price of $1,110. Initially the bonds generated total proceeds of $28.65 million and the flotation costs were $500,000. Bavarian Brew wants to sell $30 million of 5 year, $1,000 par value bonds with a 5.8% coupon rate to retire the old bonds. The flotation costs on the new bond issue are estimated to be $525,000. Due to having to issue the new bonds before the old bonds can be retired the company expects a period of 3 months were they have to pay interest on the old and the new bonds. Assume a tax rate of 34%

-Refer to Bavarian Brew Bond. What is the initial investment in the new bond issue?

A) $2,635,767
B) $3,542,433
C) $2,178,000
D) $2,845,433

Question 12

Bavarian Brew Bond
Bavarian Brew is thinking about recalling $30 million of 15 year, $1,000 par value bonds, that were issued ten years ago. The bonds carry a coupon rate of 7.8% and have a call price of $1,110. Initially the bonds generated total proceeds of $28.65 million and the flotation costs were $500,000. Bavarian Brew wants to sell $30 million of 5 year, $1,000 par value bonds with a 5.8% coupon rate to retire the old bonds. The flotation costs on the new bond issue are estimated to be $525,000. Due to having to issue the new bonds before the old bonds can be retired the company expects a period of 3 months were they have to pay interest on the old and the new bonds. Assume a tax rate of 34%

-Refer to Bavarian Brew Bond. What are the annual after tax interest payments on the old bond?

A) $1,544,400
B) $2,340,000
C) $795,600
D) $1,858,900

Question 13

Bavarian Brew Bond
Bavarian Brew is thinking about recalling $30 million of 15 year, $1,000 par value bonds, that were issued ten years ago. The bonds carry a coupon rate of 7.8% and have a call price of $1,110. Initially the bonds generated total proceeds of $28.65 million and the flotation costs were $500,000. Bavarian Brew wants to sell $30 million of 5 year, $1,000 par value bonds with a 5.8% coupon rate to retire the old bonds. The flotation costs on the new bond issue are estimated to be $525,000. Due to having to issue the new bonds before the old bonds can be retired the company expects a period of 3 months were they have to pay interest on the old and the new bonds. Assume a tax rate of 34%

-Refer to Bavarian Brew Bond. What is the NPV of the proposed bond refinancing?

A) $907,484
B) -$907,484
C) -$895,453
D) $895,453