ch7solns - Chapter 7 7-1 Income bonds do share some...

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Chapter 7 7-1 Income bonds do share some characteristics with preferred stock. The primary difference is that interest paid on income bonds is tax deductible while preferred dividends are not. Income bondholders also have prior claims on the assets, if the firm goes bankrupt. In calculating cost of capital, the primary difference again will be that the cost of income bonds will be lower, because of the tax savings. 7-2 Commodity bonds are different from straight bonds because the interest payments on these bonds are not fixed but vary with the price of the commodity to which they are linked. There is more risk, therefore, to the holder of these bonds. It is different from equity since the cash flows are constrained. Even if the commodity's price does go up, the payments on the commodity bond will go up only by the defined amount, whereas equity investors have no upside limit. Commodity bondholders also have prior claims on the assets of the firm if the firm goes bankrupt. I would treat commodity bonds as debt, but recognize that it is also debt that creates less bankruptcy risk if the firm gets into trouble due to commodity price movements. 7-3 The first characteristic - a fixed dividend and a fixed life - is a characteristic of debt, as is the last one - no voting rights. The other two - no tax deductions and secondary claims on the assets - make it more like equity. In fact, this security looks a lot like preferred stock, and I would treat it as such. 7-4 Value of Straight Preferred Stock portion of Convertible = 6/.09 = $66.67 ! Perpetual Life Value of Conversion Portion = $105 - $66.67 = $38.33 7-5 The convertible bond is a 10-year bond with a face value of $1000 and a coupon rate of 5%. If it yielded the same rate as the straight bond, i.e. 8%, its price would be equal to 25 04 1 1 104 1000 104 79615 20 20 . ( . ) . . ! + = , assuming semi-annual coupons. Hence, the equity component of the convertible can be estimated as 1100 - 796.15 = 303.85. The total equity component of the firm’s asset value = 50(1 m.) + 303.85(20000) = $56.077m. The debt component = $25m. + 796.15(20000) = 40.923m. Hence, the debt ratio = 40.923/(40.923 + 56.077) = 42.19% 7-6 Value of Equity = 50,000 * $100 + 100,000 * $90 = $14,000,000 Value of Debt = $5 million
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Debt Ratio = 5/(5+14) = 26.32% Since the debt was taken on recently, it is assumed that the book value of debt is equal to market value. 7-7 a. The cost of internal equity = 6.5 + 1.2(6) = 14.3% b. The cost of external equity = (100/95)(14.3) = 15.0526% 7-8 a. If the current owners give up 30% of the firm, they will be left with (0.7)(120) = $84m. Otherwise, they have $80m. Hence, they are better off taking the venture capital,
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This note was uploaded on 12/28/2009 for the course FEWEB CORPFIN taught by Professor Dorsman during the Spring '09 term at Vrije Universiteit Amsterdam.

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ch7solns - Chapter 7 7-1 Income bonds do share some...

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