Name: Rafi Renardi Sugiono

NIM: 20/454408/EK/22698

FM 2 Assignment 6
20-1
If company chooses to buy the equipment,
Debt ratio = Total debt / total assets = 500/900 = 0.5556 = 55.56%

If company leases,
Debt ratio = 400/800 = 0.5, meaning debt ratio would not change

Whether or not the company chooses to lease or to buy, the risk would stay the same. They
would still owe the same amount of money, just owing them to different companies.

20-2
20 year Bond without warrants and 8% annual coupon was issued at par value = $1000
20 year Bond with warrants and 6% annual coupon was issued at par value = $1000 = Value of
pure Bond + Value of warrants

Second issue:
1,000 = Bond + Warrants.
at 8 percent
N = 20
I=kd=8
PMT = 6% x 1000 = 60.
FV = 1000
PV = $803.64.
Value of warrants = S1,000 - $803.64 = S196.36.

20-3
Bond Par Value 1,000
Conversion Ratio = = = 25
S h are Price 40

20-4
A.

20-5
A. Cost of new machinery = $1,500,000

New machinery life = 3 years

Salvage value = purchase option= $250,000

Tax rate = 40%

Loan interest rate = 15%

After tax cost rate = 15 (1-40%) = 9%

Annual lease payments = $400,000

Calculation of depreciation tax savings:

Years 1 2 3 4

Depreciation Rate 33% 45% 15% 7%

Depreciation $495,000 $675,000 $225,000 $105,000

expense

Depreciation tax $198,000 $270,000 $90,000 $42,000

savings =
Depreciation x tax
rate

Cost of Owing:

Years 0 1 2 3 4

Net Purchase ($1,500,000)

Price

Depreciation $198,000 $270,000 $90,000 $42,000

Tax Savings

Net cash ($1,500,000) $198,000 $270,000 $90,000 $42,000

flows

PV of ownership @ 9%:

By using a financial calculator, input the cash flows in the cash flow register; input the
interest rate, I/YR = 9 and press the NPV key to obtain the PV cost of owing the
machinery. The answer comes out to be -$991,845.
 Years 1 2 3 4

Lease Payment ($400,000) ($400,000) ($400,000) ($400,000)

Tax Savings $160,000 $160,000 $160,000 $160,000

Cost to ($250,000)
Purchase

Net Cash ($240,000) ($240,000) ($240,000) ($490,000)

Flows

PV of leasing @ 9%:

By using a financial calculator, input the cash flows in the cash flow register; input the
interest rate, I/YR = 9 and press the NPV key to obtain the PV cost of owing the
machinery. The answer comes out to be -$954,639.

Cost comparison:

PV ownership cost @9% = -$991,845

PV of leasing @9% = -$954,639

Net Advantage to Leasing (NAL) $37,206

Morris-Meyer should lease the equipment since leasing has a $37,206 net advantage over
buying.

B. The rate at which the cash flows are discounted is a crucial consideration. We know that
the higher the discount rate used to calculate the present value of a cash flow, the riskier
it is. The majority of the rates are fixed, at least when compared to the sorts of cash flow
estimations utilized in capital budgeting analysis, such as lease, loan, and maintenance
payments, which are determined by contracts, and depreciation expenditure and tax rates,
which are set by law and unlikely to change. The predicted salvage value of $250,000 is
the least certain of the cash flows, however even this estimate is based on previous
experience. If the lease plan is employed, we presume Morris-Meyer will buy the
equipment at the conclusion of the four years; so, the $250,000 is an additional cost under
leasing. Because the residual value uncertainty increases the unpredictability of
operations under the lease alternative, it seems appropriate to apply a lower rate to
penalize the lease selection.

20-6
A. Exercise value = Current stock price - strike price
 Stock price Strike price Exercise value

$18 $21 -$3, considered $0

$21 $21 $0

$25 $21 $4

$70 $21 $49

B. Current Price, P0 = $18, Warrant = $1.50, Premium = $4.50.

Current Price, P0 = $21, Warrant = $3.00, Premium = $3.00.

Current Price, P0 = $25, Warrant = $5.50, Premium = $1.50.

Current Price, P0, = $70, Warrant = $50.00, Premium = $1.00.

C. 1. The value of a warrant increases as the life of the warrant is extended.

2. The value of a warrant will be reduced if the predicted variability in stock prices
reduces.
3. The warrant price will rise if the stock's projected EPS growth rate increases.
4. Increases in the payout ratio limit the predicted growth rate and, as a result, reduce the
likelihood of future stock price increases. As a result, the warrant's estimated value would
be smaller, lowering the premium and price.

D. Value of warrants = 50 x $1.50 = $75

Price paid for bond with warrants = Straight-debt value of bond + Value of warrants
Price paid for bond with warrants = $1,000
1,000 = Straight-debt value of bond + 75
Straight-debt value of bond = $925
Input N = 20, I/YR = 10, PV = -925, FV = 1000 into a financial calculator and push
PMT. The answer is $91.19, or approximately $90.

Coupon interest rate = 90/1000 = 0.09 = 9%

20-7
A. Investors may believe the premium over the purchase price should be in the 20-30%
range, and since management predicts a future growth rate of 10% per year, we can place
the premium near the middle of the range, at 25%.
A 25% premium results in =
 Conversion price = $21 x 1.25 = $26.25
B. Yes, a call provision should be included in the preferred stock to force conversion if the
market price climbs above the call price.