Chapter 18

18-1

a. $5 per share
Gross proceeds = (3,000,000)($5) = $15,000,000.
Net profit = $15,000,000 - $14,000,000 - $300,000 = $700,000.
b. $6 per share
Gross proceeds = (3,000,000)($6) = $18,000,000.
Net profit = $18,000,000 - $14,000,000 - $300,000 = $3,700,000.
c. $4 per share
Gross proceeds = (3,000,000)($4) = $12,000,000.
Net profit = $12,000,000 - $14,000,000 - $300,000 = $2,300,000.

18-2

Net proceeds per share = $22(1 - 0.05) = $20.90.

Number of shares to be sold = ($20,000,000 + $150,000)/$20.90 = 964,115 shares.

18-7

a. Investment outlay required to refund the issue (all figures after-tax):

Mini Case: 18 - 1
2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.

Call premium on old issue:

New flotation cost:
Tax savings on old flotation:
Additional interest on old issue:
Interest earned on investment:
Total investment outlay:

$5,400,000
5,000,000
(1,666,667)
450,000
(225,000)
$8,958,333

Annual Flotation Cost Tax Effects:

Annual tax savings on new flotation:
Tax benefits lost on old flotation:
Amortization tax effects

$ 80,000
(66,667)
$ 13,333

Annual Interest Savings Due to Refunding:

Annual interest on old bond:
Annual interest on new bond:
Net interest savings

$5,400,000
(4,500,000)
$ 900,000

Annual cash flows:

$ 913,333

NPV of refunding decision:

$2,717,128

Using a financial calculator, enter the cash flows into the cash flow register, I = 6,
NPV = ? NPV = $2,717,128.
b. The company should consider what interest rates might be next year. If there is a
high probability that rates will drop below the current rate, it may be more
advantageous to refund later versus now. If there is a high probability that rates will
increase, the firm should act now to refund the old issue. Also, the company should
consider how much ill will is created with investors if the issue is called. If Tarpon is
highly dependent on a small group of investors, it would want to avoid future
difficulty in obtaining financing. However, bond issues are callable after a certain
time and investors expect them to be called if rates drop considerably.

Chapter 19
Mini Case: 18 - 2
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website, in whole or in part.

19-2

Cost of owning:

Cost
Depreciation shield

(200)

40
40

40
40

(66)

(66)

(200)

PV at 6% = -$127.
Cost of leasing:
|

After-tax lease payment

PV at 6% = -$128.
NAL = $128 ($127) = $1.
Reynolds should buy the equipment, because the cost of owning is less than the cost of
leasing.

Mini Case: 18 - 3
2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.

19-3

a. Balance sheets before lease is capitalized:

Energen
Balance Sheet (Owns new assets)
(Thousands of Dollars)

Current assets
Fixed assets
Total assets

$ 25,000
175,000
$200,000

Debt
Equity
Total claims

$100,000
100,000
$200,000

Debt/assets ratio = $100/$200 = 50%.

Hastings Corporation
Balance Sheet (Leases as operating lease)
(Thousands of Dollars)
Current assets
Fixed assets
Total assets

$ 25,000
125,000
$150,000

Debt
Equity
Total claims

$ 50,000
100,000
$150,000

Debt/assets ratio = $50/$150 = 33%.

b. Balance sheet after lease is capitalized:
Hastings Corporation
Balance Sheet (Capitalizes lease)
(Thousands of Dollars)
Current assets
Value of leased asset
Fixed assets
Total assets

$ 25,000
50,000
125,000
$200,000

Debt
PV of lease payments
Equity
Total claims

$ 50,000
50,000
100,000
$200,000

Debt/assets ratio = $100/$200 = 50%.

19-4
I. Cost of Owning:
0
After-tax loan paymentsa
Depr. tax savingsb
Residual value
Tax on residual
Net cash flow

$0

1
($135,000)
$199,980

$4,980

2
($135,000)
$266,700

3
($135,000)
$88,860

$131,700

($46,140)

4
($1,635,000)
$44,460
$250,000
($100,000)
($1,440,540)

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website, in whole or in part.

PV of owning at 9% = $885,679.47
II. Cost of Leasing:
0
Lease payment (AT)
Net cash flow

$0

1
(240,000)
(240,000)

2
(240,000)
(240,000)

3
(240,000)
(240,000)

4
(240,000)
(240,000)

PV of leasing at 9% = $777,532.77
III. Cost Comparison
Net advantage to leasing (NAL)= PV of leasing - PV of owning
= $777,532.77 ($885,679.47)
= $108,146.69.
a

After-tax interest payments = (0.15)($1,500,000)(1-0.40) = $135,000.

Depreciation tax savings, base on MACRS 3-year life and $1,500,000 cost of new
machinery:.

Year
1
2
3
4

MACRS
Allowance Factor
0.3333
0.4445
0.1481
0.0741

Deprec. Tax Savings

Depreciation
T (Depreciation)
$499,950
$199,980
666,750
266,700
222,150
88,860
111,150
44,460

Since the cost of leasing the machinery is less than the cost of owning it, Big Sky Mining
should lease the equipment.

Mini Case: 18 - 5
2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.