A. is financed with short-term debt
B. is financed with long-term debt.
C. is financed with debt whose maturity matches the term of the lease.
D. is financed with a mix of debt and equity based on the firm's target capital structure, i.e. at the WACC.
E. is financed with retained earnings.
2. In the lease versus buy decision, leasing is often preferable.
A. because it has no effect on the firm's ability to borrow to make other investments.
B. because, generally, no down payment is required and there are no indirect interest costs.
C. because lease obligations do not affect the firm's risk as seen by investors.
D. because lessee owns the property at the end of the lease term.
E. because the lessee may have greater flexibility in abandoning the project in which the leased propertty is used than if the lessee bought and owned the asset.
3. The City of Charleston issued $3,000,000 of 8% coupon, 30-year, semiannual payment, tax-exempty muni bonds 10 years ago. The bonds had 10 years of call protection, but now the bonds can be called if the city chooses to do so. The call premium would be 6% of the face amount. New 20-year 6% semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2% of the amount of bonds sold. What is the net present value of refunding? Note that cities pay no income taxes, hence taxes are not relevant.
4. Tuttle Buildings Inc. has decided to go public by selling $5,000,000 of new common stock. Its investment bankers agreed to take a smaller fee now (6% of gross proceeds versus their normal 10%) in exchange for a 1-year option to purchase an additional 200,000 shares at %5,00 per share. The investment bankers expect to exercise the option and purchase the 200,000 shares in exactly one year, when the stock price is forecasted to be $6.50 per share. However, there is a chance that the stock price will actually be $12,00 per share one year from now. If the $12 price occurs what would the present value of the entire underwriting compensation be? assume that the investment banker's required return on such arrangement is 15% and ignore taxes.
A. residual value of 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 an offsetting liability.
E. undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability.
6. A central question that must be addressed in bankruptcy proceedings is whether the firm's inability to meet scheduled interest payments results from a temporary cash flow problem or from a potentially permanent problem caused by falling asset values.
7. Operating leases often have terms that include
A. maintenance of the equipment by the lessor.
B. full amortization over the life of the lease.
C. very high penalties if the lease is cancelled.
D. restrictions on how much the leased property can be used.
E. much longer lease periods than for most financial leases.
8. The primary test of feasibility in a reorganization is whether the firm's fixed charges after reorganization can be covered by its projected cash flows.
9. Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?
A. The yield to maturity on the company's outstanding bonds increases due to a weakening of the firm's financial situation.
B. A provision in the bond indenture lowers the call price on specific dates, and yesterday was on of those dates.
C. The flotation costs associated with issuing new bonds rise.
D. The firm's CFO believes that interest rates are likely to decline in the future.
E. The firm's CFO believes that corporate tax rates are likely to be increased in the future.
10. Thompson Enterprises has $5,000,000 of bonds outstanding. Each bond has a maturity value of $1,000, an annual coupon of 12.0% and 15 years left to maturity. The bonds can be called at any time with a premium of $50 per bond. If bonds are called, the company must pay flotation costs of $10 per new refunding bond. Ignore tax considerations--assume that the firm's tax rate is zero.
The company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds. What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?
11. Kohers Inc. is considering a leasing arrangement to finance some manufacturing tools that it needs for the next 3 years. The tools will be obsolete and worthless after 3 years. The form will depreciate the cost of the tools on a straight-line basis over their 3-year life. It can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases. What is the net advantage to leasing (NAL), in thousands?
12. Which of the following statements is most CORRECT?
A. If new debt is used to refund old debt, the correct discount rate to use in the refunding analysis is the before-tax cost of new debt.
B. The key benefits associated with refunding debt are the reduction in the firm's debt ratio and the creation of more reserve borrowing capacity.
C. The mechanics of finding the NPV of a refunding decision are fairly straightforward. However, the decision of when to refund is not always clear because it requires a forecast of future interest rates.
D. If a firm with a positive NPV refunding project delays refunding and interest rates rise, the firm can still obtain the entire NPV by locking in a low coupon rate when the rates are low, even though it actually refunds the debt after rates have risen.
E. Suppose a firm is considering refunding and interest rates rise during time when analysis is being done. The rise in rates would tend to lower the expected price of the new bonds, which would make them cheaper to the firm and thus increase the expected interest savings.
13. From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's
14. Chapter 7 of the Bankruptcy Act is designed to do which of the following?
A. Protect shareholders against creditors.
B. Establish the rules of reorganization for firms with projected cash flows that eventually will be sufficient to meet debt payments.
C. Ensure that the firm is viable after emerging from bankruptcy.
D. Allow the firm to negotiate with each creditor individually.
E. Provide safeguards against the withdrawal of assets by the owners of the bankrupt firm and allow insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt.
15. In the event of bankruptcy under the federal bankruptcy laws, debtholders have a prior claim to a firm's income and assets before both common and preferred stockholders. Moreover, in a bankruptcy all debtholders are treated equally as a single class of claimants.
The excel file includes multiple questions on leases and bankruptcy
Bond Valuation, Stock Valuation, Preferred Stock Required Return, Preferred Stock Valuation, Bond Valuation/ YTM/ Interest Rate Risk, Bond Returns, Stock/ Business Valuation, CAPM
Capital Structure Decisions & Credit Ratings
Dividend Adjustment Model
Bond Funding: Public/Private Placement
Net Advantage to Leasing
A1. A $ 1,000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bond's coupon rate is 7.4%. What is the fair value of this bond?
A 10. (Dividend Discount model) Assume RHM is expected to pay a total cash dividend of $5.60 next year and its dividends are expected to grow at a rate of 6% per year forever. Assuming annual dividend payments, what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%?
A12. (Required return for preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividend is nongrowing. What is the required return on James River preferred stock?
A 14. (Stock valuation) Suppose Toyota has nonmaturing (perpetual) preferred stock outstanding that pays a $1.00 quarterly dividend and has a required return of 12% APR. What is the stock worth?
B 16. (Interest rate risk) Philadelphia Electric has many bonds trading on the New York Stock Exchange. Suppose PhilEl's bonds have identical coupon rates of 9.125% but that one issue matures in 1 year, one in 7 years, and the third in 15 years. Assume that a coupon payment was made yesterday
a. If the yield to maturity for all three bonds is 8%, what is the fair price of each bond?
b. Suppose that the yield to maturity for all of these bonds changed instantaneously to 7%. What is the fair price of each bond now?
c. Suppose that the yield to maturity for all of these bonds changed instantaneously again, this time to 9%. Now what is the fair price of each bond?
d. Based on the fair prices at the various yields to maturity, is interest-rate risk the same, higher, or lower for longer-versus shorter-maturity bonds?
B 18. (Default risk) You buy a very risky bond that promises a 9.5% coupon and return of $1,000 principal in 10 years. You pay only $500 for the bond.
a) You receive the coupon payments for three years and the bond defaults. After liquidating the firm, the bondholders receive a distribution of $150 per bond at the end of 3.5 years. What is the realized return on your investment?
b) The firm does far better than expected and bondholders receive all of the promised interest and principal payments. What is the realized return on your investment?
B 20. (Constant growth model) Medtrans is a profitable firm that is not paying a dividend on its common stock. James Weber, an analyst for A.G. Edwards, believes that Medtrans will begin paying a $1.00 per share dividend in two years and that the dividend will increase 6% annually thereafter. Bret Kimes, one of James' colleagues at the same firm, is less optimistic. Bret thinks that Medtrans will begin paying a dividend in four years, that the dividend will be $1.00, and that it will grow at 4% annually. James and Bret agree that the required return for Medtrans is 13%.
a. What value would James estimate for this firm?
b. What value would Bret assign to the Medtrans stock?
C1. (Beta and required return) The riskless return is currently 6%, and Chicago Gear has estimated the contingent returns given here.
a. Calculate the expected returns on the stock market and on Chicago Gear stock.
b. What is Chicago Gear's beta?
c. What is Chicago Gear's required return according to the CAPM?
State of the market Probability that state occurs Stock market Chicago Gear
Stagnant 0.20 -10.00% -15.00%
Slow growth 0.35 10.00% 15.00%
Average growth 0.30 15.00% 25.00%
Rapid growth 0.15 25.00% 35.00%
B1. (Choosing financial targets) Bixton Company's new chief financial officer is evaluating Bixton's capital structure. She is concerned that the firm might be underleveraged, even though the firm has larger-than-average research and development and foreign tax credits when compared to other firms in its industry. Her staff prepared the industry comparison shown here.
a. Bixton's objective is to achieve a credit standing that falls, in the words of the chief financial officer, "comfortably within the 'A' range." What target range would you recommend for each of the three credit measures?
b. Before settling on these target ranges, what other factors should Bixton's chief financial officer consider?
c. Before deciding whether the target ranges are really appropriate for Bixton in its current financial situation, what key issues specific to Bixton must the chief financial officer resolve?
Rating Category Fixed Charge Coverage Funds From Operations/Total Debt Long-Term Debt/Capitalization
Aa 4.00-5.25x 60-80% 17-23%
A 3.00-4.30 45-65 22-32
Baa 1.95-3.40 35-55 30-41
A10. (Dividend adjustment model) Regional Software has made a bundle selling spreadsheet software and has begun paying cash dividends. the firm's chief financial officer would like the firm to distribute 25% of its annual earnings (POR = 0.25) and adjust the dividend rate to changes in earnings per share at the rate ADJ = 0.75. Regional paid $1.00 per share in dividends last year. It will earn at least $8.00 per share this year and each year in the foreseeable future. Use the dividend adjustment model, Equation (18.1), to calculate projected dividends per share for this year and the next four.
B2. (Dividend policy) A firm has 20 million common shares outstanding. It currently pays out $1.50 per share year in cash dividends on its common stock. Historically, its payout ratio has ranged from 30% to 35%. Over the next five years it expects the earnings and discretionary cash flow shown below in millions.
A.over the five year period, what is the maxium overall payout ratio the firm could acieve without triggering a securities issue?
B. Recommend a reasonable dividend policy for paying out discretionary cash flow in years 1 through 5.
1 2 3 4 5 Thereafter
Earnings 100 125 150 120 140 150+ per year
Discrecreary cash flow 50 70 60 20 15 50+per year
A2. (Comparing borrowing costs) Stephens Security has two financing alternatives: (1) A publicly placed $50 million bond issue. Issuance costs are $1 million, the bond has a 9% coupon paid semiannually and the bond has a 20-year life. (2) A $50 million private placement with a large pension fund. Issuance costs are $500,000, the bond has a 9.25% annual coupon, and the bond has a 20-year life. Which alternative has the lower cost (annual percentage yield)?
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