The Bowman Corporation has a $20 million bond obligation outstanding, which it is considering refunding.
Though the bonds were initially issued at 12 percent, the interest rates on similar issues have declinedto 10.5 percent. The bonds were originally issued for 20 years and have 15 years remaining. The new issuewould be for 15 years. There is an 8 percent call premium on the old issue. The underwriting cost on the new $20 million issue is $570,000, and the underwriting cost on the old issue was $400,000. The company is in a 35 percent tax bracket, and it will use a 7 percent discount rate (rounded after-tax cost of debt) to analyze the refunding decision.
Should the old issue be refunded with new debt?
Problem 20 B
Howell Auto Parts is considering whether to borrow funds and purchase an asset or to lease the asset under an operating lease arrangement.If the company purchases the asset, the cost will be $10,000. It can borrow funds for four years at 12%. The firm will use the three year MACRS depreciation category(with the associated 4-year write off). Assume a tax rate of 35%
a. Compute the aftertax cost of the lease for 4 years.
b. Compute the annual payment for the loan.
c.Compute the amortization schedule for the loan.
d. Determine the depreciation schedule.
e. Compute the after tax cost of borrow-purchase alternative.
f.Compute the present value of the aftertax cost of the two alternatives. Use a discount rate of 8%
g.Which alternative should be selected, based on miimizing the present value of aftertax costs?
1. Which of the following is not a potential benefit of a merger? (Points : 5)
Improved Financing Posture
Dilution of Earnings Per Share
Tax Loss Carryforward
2. The Haavelmo Widget Corporation has just signed a 60-month lease on an asset with a 6-year life. The lessor will retain the property at the end of the lease, and the present value of the minimum lease payments is $470,000. The estimated fair value of the property is $600,000. Is this an operating lease? (Points : 5)
if the company elects to treat the lease as an operating lease
more information is required
3. An example of a horizontal merger would be: (Points : 5)
Pepsi and Sears.
McDonalds and Pillsbury.
Pepsi and Frito Lay.
Coca Cola and Dr. Pepper.
4. Which of the following are advantages of leasing? (Points : 5)
A lease obligation may be substantially less restrictive than the provisions of a bond indenture.
There may be no down payment as in a purchase.
The negative effects of obsolescence may be eliminated.
All of these.
5. A serial bond repayment plan involves a: (Points : 5)
lump-sum payment at maturity.
conversion of debt to common stock.
an early redemption of all debt.
series of installments to retire the debt over the life of the issue.
6. An indenture is: (Points : 5)
the section of a corporation’s bylaws pertaining to bond issues.
the summary of the essential features of a stock issue.
the contract between a corporation and a trustee acting for bondholders.
the underwriting contract.
7. A business combination of two or more companies in which the resulting firm maintains the identity of the acquiring company is defined as a: (Points : 5)
8. An operating lease: (Points : 5)
has a lease term equal to 75% or more of the estimated property.
is usually short-term and is often cancelable at the option of the lessee.
must show up on the balance sheet.
none of these.
9. Buchanan Corp. is refunding $10 million worth of 10% debt. The new bonds will be issued for 8%. The corporation’s tax rate is 35%. The call premium is 9%. What is the net cost of the call premium? (Points : 5)
10. Which of the following types of mergers is most likely to lead to diversification benefits? (Points : 5)
Tax free exchange
11. Which of the following is not a form of compensation that selling stockholders could receive? (Points : 5)
Fixed Income Securities
12. The “call” provision on some bonds allows: (Points : 5)
the bondholder to redeem the bond earlier than maturity, but usually involves a call premium.
the corporation to request additional capital contributions from the bondholder.
the corporation to redeem the bonds earlier than maturity but usually for a premium over the par value.
the bondholder to convert the bond into preferred stock.
13. The higher the tax rate, the ______ the net underwriting cost on the new bond issue. (Points : 5)
higher or lower
14. Which one of these conditions must be met for a lease to qualify as a capital lease? (Points : 5)
The lease contains a bargain purchase price at the end of the lease.
The lease must have a value of at least $10 million.
The lease must have a life of 10 years.
All of these.
15. Which of the following bonds offers the most security to the bondholder? (Points : 5)
Junior mortgage bonds
Senior mortgage bonds
16. A call provision, which allows the corporation to force an early maturity on a bond issue, usually contains all but which of the following characteristics? (Points : 5)
Most bonds must be outstanding at least 5 years before being called.
After the call date, the call premium tends to decline over time.
The provision typically calls for debt conversion into common stock.
The corporation will pay a premium over par for the bonds.
17. The rising ratio of divestitures to new acquisitions which occurred in the past suggests that: (Points : 5)
poison pills are no longer effective as a defense against takeovers.
too much diversification strained the operating capabilities of many firms.
the portfolio effect has been a highly successful method of reducing risk.
multinational firms are increasingly considered highly risky investments.
18. Bond refunding occurs when: (Points : 5)
interest rates in the market are sufficiently less than the coupon rate on the old bond.
interest rates in the market have risen over the coupon rates on the old bond.
the price of the old bond is less than par.
the sinking fund has accumulated enough money to retire the bond issue.
19. The main cause for the increase in corporate debt in America is: (Points : 5)
rapid business expansion.
inadequate internally-raised funds.
All of these.
20. Floating rate bonds are most likely to be popular with investors when it is anticipated that: (Points : 5)
interest rates will stay the same.
interest rates will go up.
interest rates will go down.
short-term interest rates will be higher than long-term interest rates.