PROBLEM 1 Preferred Stock Refunding

Tom Corporation is considering replacing its $40 million, preferred shares issue because market rates (yields) have declined. The existing preferred carry a dividend of $6.00, which is a rate of 10% on the par value. Current market rates on new preferred shares would be 8% on the par value. Toms preferred are currently selling for $75. Underwriter expenses on the new preferred share issue would be 6% before tax. Corporate tax rate is 30%. Cost of capital = 14%. There would be a two-month dividend overlap. The firm could invest funds received from the underwriter for one month at 4%.

REQUIRED - Should Tom Corporation replace its existing preferred shares?

PROBLEM #2 - Lease or Buy Equipment

Byrd Ltd, a newly incorporated company, has decided to acquire the use of new updated equipment for its manufacturing plant in High River Alberta. As such the company has found a lessor that would give a non-cancelable operating lease for 20 years, involving beginning of the year annual lease payments of payments of $32,000.

Byrd other option is to purchase the equipment. In order to finance the acquisition, it could obtain a 15 year, $400,000, 12 percent bank loan to be repaid in equal end-of-year installments. At the end of the 20^th year it is estimated that the equipment could be sold for its estimated fair market value $70,000. At the end of year 10, the equipment will require a $160,000 capital upgrade. The firm will be required to pay annual beginning of the year repair expenses of $12,000 per year. Byrd has a corporate tax rate of 30%. The firms cost of capital is 14%. The CCA rate is 20%.

REQUIRED: Should Byrd Lease or Buy.

PROBLEM #3 - Bond Refunding

Marsh Company is contemplating calling an outstanding $40 million bond issue and replacing it with a new $40 million bond issue. The firms corporate tax rate is 40%. The old and new bonds are described below.

OLD BONDS: Have a $1,000 face value, 11% coupon rate. They were initially issued 7 years ago with 30 year maturity. They were initially sold at par. The bond has a sliding scale penalty for the bond premium. The premium is 7% starting in year 5. The premium declines by 1% per year.

NEW BONDS: Have a $1000 face value, interest rate of 9% and would be sold at par. Their maturity would match the remaining years left with the old bond issue. The underwriter fee would be 5 % before tax. Cost of capital = 15%. There would be a three month interest overlap period. The firm could invest funds received from the underwriter from the sale of new bonds at 4% for two month.

REQUIRED: Should the firm refund the old bond issue?

PROBLEM #4 - Lease or Buy Land

Edison Ltd, has decided to acquire the use of three hectors of land to store drilling equipment. As such the company has found a lessor in Medicine Hat, Alberta that would give a non-cancelable operating lease for 10 years, involving beginning of the year lease payments of $50,000 per year .

Edison Ltd., other option is to buy the land. In order to finance the acquisition, it could obtain an 10 year, $200,000, 10 percent bank loan to be repaid in equal end-of-year installments. It is expected that the land would appreciate in value by 4 percent per year. At the end of the 10^th year the land will be sold for its appreciated fair market value. The firm would be required to pay property of $9,000 per year, at the end of each year. Edison Ltd. Has a corporate tax rate of 40 percent. The firms cost of capital is 13 percent.

Required: Should Edison Lease or Buy?

PROBLEM #5 - Bond Yields

The Pioneer Company has a $1,000 face value bond outstanding with a $90.00 annual interest payment, a market price of $875, and a maturity of 10 years.

Required: Calculate the following percentages.

1. The coupon Rate. (1 mark)
2. The current rate (yield) (1 mark)
3. The yield to maturity (2 marks)