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Exam 20: Hybrid Financing: Preferred Stock, Leasing, Warrants, and Convertibles

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Question 21

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Statement of Financial Accounting Standards #13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the

A) residual value as a fixed asset.
B) residual value as a liability.
C) present value of future lease payments as an asset and also showing this same amount as an offsetting liability.
D) undiscounted sum of future lease payments as an asset and as an offsetting liability.
E) undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability.

F) D) and E)
G) None of the above

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Question 22

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Orient Airlines' common stock currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2020. What is the conversion value of the bond?

A) $707.33
B) $744.56
C) $783.75
D) $825.00
E) $866.25

F) A) and B)
G) B) and C)

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Question 23

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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.

Upstate Water Company just sold a bond with 50 warrants attached. The bonds have a 20-year maturity and an annual coupon of 12%, and they were issued at their $1,000 par value. The current yield on similar straight bonds is 15%. What is the implied value of each warrant?

Which of the following statements concerning warrants is most CORRECT?

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

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?

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.

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.

Ballentine Inc. 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?

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?

Which of the following is most CORRECT?

Herring Inc. is considering issuing 15-year, 8% semiannual 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 nominal yield of 10%. What is the straight-debt value of the bond at the time of issue?

Herbert Engineering is issuing new 15-year bonds that have warrants attached. If not for the attached warrants, the bonds would carry a 9% annual interest rate. However, with the warrants attached the bonds will pay a 6% annual coupon. There are 30 warrants attached to each bond, which has a par value of $1,000. What is the value of the straight-debt portion of the bonds?

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

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?

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

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

If a leased asset has a negative residual value, for example, as a result of a statutory requirement to dispose of an asset in an environmentally sound manner, the lessee of the asset could reasonably expect to pay a lower lease rate because the asset does not have a positive residual value.

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.