20.1) Connors construction needs a piece of equipment that can be leased or purchased. The equipment costs $ 100.One option is to borrow $ 100 from the local bank and use the money to buy the equipment. The other option is to lease the equipment. The company’s balance sheet prior to the equipment purchases or lease is shown below.
Current assets $ 300
Fixed assets 500
Total assets $ 800
Debt $ 400
Total liabilities and equity $ 800
What would be the company’s debt ratio if it chose to purchase the equipment ?What would be the company’s debt ratio if it leased the equipment and it could keep the lease of its balance sheet? Is the company’s financial risk any different whether the equipment is leased or purchased? Explain
20-2)Gregg Company recently issued two types of bonds. The first issue consisted of 20 year straight (no warrants attached.)
bonds with an 8% annual coupon. The second issue consisted of 20 year bond with an 6% annual coupon with warrants attached.
Both bonds were issued at par $ 1,000.What is the value of the warrants that were attached to the second issue.?
20-3)Petersen Securities recently issued convertible bonds with a $ 1,000 par value. The bonds have a conversion price of $ 40 per share. What is the bonds conversion ratio,CR?
20-5)Morris Meyer Mining company must install $ 1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the required amount. Alternatively a Nevada investment banking firm that represents a group of investors believes that it can arrange for a lease financing plan. Assume that the following facts apply.
1.)The equipment falls in the MACRS 3 year class. The applicable MACRS rates are 33% ,45%,15% and 7%.
2.)Estimated maintains expenses are $ 75,000 per year.
3.)Morris Meyer’s federal plus state tax rate is 40% .
4.)If the money is borrowed the bank will be at a rate of 15%,amortized in 4 equal installments to be paid at the end of each year.
5.)The tentative lease terms call for end of the year payments of $ 400,000 per year for 4 years.
6.)Under the proposed lease terms the lessee must pay for insurance property taxes and maintenance.
7.)Morris Meyer must see the equipment if it is to continue in business, so it will almost certainly want to acquire the property at the end of the lease. If it does, under the lease terms it can purchase the machinery at its fair market value, but it may be much higher or lower under certain circumstances.
To assist management in making the proper lease versus buy decision you are asked to answer the following questions.
a.)Assuming that the lease can be arranged, should Morris Meyer lease or borrow and buy the equipement.Why.?
b.)Consider the $ 250,000 estimated salvage value.Is it appropriate to discount it at the same rate as the other cash flows? What about the other cash flows are they all equally risky?
Explain(Hint:riskery cash flows are normally discounted at higher rates, but when the cash flows are costs rather then inflows, the normal procedure must be revised.
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