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FIN 450 MODULE 6 PROBLEMS

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17-4 Lease versus purchase JLB Corporation is attempting to
determine weather to lease or purchase research equipment. The
firm is in the 40% tax bracket, and its after- tax cost of debt is
currently 8%. The terms in the leases and or purchase are as
follows.
LEASE-Annual end of year lease payments of $25,200 are required
over the 3-year life of the lease. All maintenance cost will be borne
by the lease. The lessee will exercise its option to purchase the
asset for $5,000 at termination of the lease.
PURCHASE-The research equipment, coasting $60,000, can be
financed entirely with a 14% loan requiring end-of-year payments of
$25,844 for three years. The firm in this case will depreciate the
equipment under MACRS using a 3-year recovery period. ( See table
4.2 on page 120 for applicable depreciation percentages) The firm
will pay $1,800 per year for the service contract that covers all
maintenance cost; insurance and other costs will be borne by the
firm. The Firm planes to keep the equipment and use it beyond its 3year recovery period.
a) Calculate the after tax cash outflows associated with each
alternative.
b) Calculate the present value of each cash outflow stream, using
the after tax cost of debt.
c) Which alternativelease or purchasewould you recommend?
Why?
Table 4.2---------Percentage by recovery year
Recovery year

3 years

5 years

7 years

10 years

33%

45

15

20%

14%

10%

32

25

18

19

18

12

14

12

12

12

6
6

10

11
Total
100%

4
100%

100%

100%

P176 Lease-versus-purchase decision Joanna Browne is


considering either leasing or purchasing a new Chrysler Sebring
convertible that has a manufacturers suggested retail price
(MSRP) of $33,000. The dealership offers a 3-year lease that
requires a capital payment of $3,300 ($3,000 down payment 1 $300
security deposit) and monthly payments of $494. Purchasing
requires a $2,640 down payment, sales tax of 6.5% ($2,145), and 36
monthly payments of $784. Joanna estimates that the value of the
car will be $17,000 at the end of 3 years. She can earn 5% annual
interest on her savings and is subject to a 6.5% sales tax on
purchases. Make a reasonable recommendation to Joanna using a
lease-versus-purchase analysis that, for simplicity, ignores the time
value of money.
a. Calculate the total cost of leasing.
b. Calculate the total cost of purchasing.

c. Which should Joanna do?


17.8 Conversion price Calculate the conversion price for each of the
following conversion bounds;
a) A $1,000-par-value bound that is convertible into 20 shares of
common stock.
b) A $500-par-value bond that is convertible into 25 shares of
common stock.
c) A $1,000-par-value bond that is convertible into 50 shares of
common stock.

17.14 Determining values; Conversion bond Craigs Cake Company


has and outstanding issue of 15-year convertible bonds with a
$1,000 par value. These bonds are convertible into 80 shares of
common stock. They have a 13% annual coupon interest rate,
whereas the interest rate on strait bonds of similar risk is 16%.
a) Calculate the strait bond value of this bound.
b) Calculate the conversion (or stock) value of the bond when the
market price is $9, $12, $15, and $20 per share of common stock.
c) For each of the common stock prices given in part b, at what price
would you expect the bond to sell?
d) Make a graph of the straight value and conversion

P17-19
Tom Baldwin an invest $6300 in the common stock or the warrants
of Lexington Life Insurance. The common stock is currently selling
for $30 per share. Its warrants, which provide for the purchase of
two shares of common stok at $28 per share, are currently selling
for $7. The stock is expected t o rise to a market price of $32 within
the next year, so the expected theoretical value of the warrant over
the next year is $8. The expiration date of the warrant is 1 year from
the present.

a. If Mr. Baldwin purchases the stock, holds it for 1 year, and then
sells it for $32, what is his total gain? (Ignore brokerage fees and
taxes?
b. If Mr. Baldwin purhases the warrants and converts them to
common stock in 1 year, what is his total gain if the market price of
common shares is actually $32? Ignore brokerage fees and taxes)
c. Repeat parts a and b, assuming that the market price of the stock
in 1 year is 1. $30 and 2. $28.
d. Discuss the two alternatives and the dradeoffs associated with
them.

P17-21
Carol Krebs is considering buying 100 shares of Sooner Products, Inc
at $62 per share. Because she has read that the firm will probably
soon receive certain large orders from abroad, she expects the price
of Sooner to increase to $70 per share. As an alternative, Carol is
considering purchase of a call option for 100 shares of Sooner at a
strike price of $60. The 90-day option will ost $600. Ignore any
brokerage fees or dividends.

a. What will Carol's profit be on the stock transaction if its price does
rise to $70 and she sells?
b. How much will Carol earn on the option transaction if the
underlying stock price rises to $70?
c. How high must the stock price rise for Carol to break even on the
option transaction?
d. Compare, contrast, and discuss the relative profit and risk
associated with the stock and the option transactions?