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Finance Questions: KIC, Inc. and Leases R Us

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#1. KIC, Inc., plans to issue $6 million of perpetual bonds.The face value of each bond is $1,000.
The annual coupon on the bonds is 9 percent. Market interest rates on one-year bonds are
8 percent.With equal probability, the long-term market interest rate will be either 12 percent
or 6 percent next year. Assume investors are risk-neutral.
a. If the KIC bonds are noncallable,what is the price of the bonds?
b. If the bonds are callable one year from today at $1,250, will their price be greater than
or less than the price you computed in (a)? Why?

#2. Leases R Us, Inc Problem-Calculating Annual Payments Leases R Us, Inc. (LRU) has been contracted by Robotics of Beverly Hills (RBH) to provide lease financing for a machine that would assist in automating a large part of their current assembly line. Annual lease payments will start at the beginning of each year. The purchase price of this machine is $250,000, and it will be leased by RBH for a period of 5 years. LRU will utilize straight line depreciation of $50,000 per year with a zero book salvage value. However, salvage value is estimated to actually be $50,000 at the end of 5 years. LRU is required to earn a 12%, after-tax rate of return on the lease. LRU uses a marginal tax rate of 35%. Calculate the annual lease payments. (Remember, these payments are to be considered at the beginning of each year-annuity due.)
Hints for students:
There are 3 major steps that need to be accomplished in order to calculate the annual lease payment.
Step A: You need to calculate the amount to be amortized. This would be the cost of the machine less the PV of the after tax salvage value of the machine and less the PV of the depreciation tax shield
Step B: You need to calculate the annual after-tax required lease income. (Remember, in this step, you need to calculate it as an annuity due-a beginning of the year payment.) Take your answer from Step A as a present value, and using the number of years and the required rate of return, calculate the payment.
Step C: Calculate the lease payment. You need to adjust for the appropriate tax rate. Therefore, take your answer in Step B and divide it by (1 - the tax rate). This will give you the required lease payment.

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