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Asset Management is an important subject in Economics. In these Lecture Slides, following concepts are discussed : Hybrid Financing, Preferred Stock, Leasing, Warrants, Convertibles, Preferred Stock, Leasing, Warrants, Convertibles, Off Balance Sheet
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20-120-
Preferred stock Leasing Warrants Convertibles
20-
Often referred to as “off balance sheet” financing if a lease is not “capitalized.”
Leasing is a substitute for debt financing and, thus, uses up a firm’s debt capacity. - Capital leases are different from operating leases: - Capital leases do not provide for maintenance service. - Capital leases are not cancelable. - Capital leases are fully amortized.
20-
Depreciable basis
Depreciation End
of
Year Year Rate Expense Book Value 1
20-
Since cash flows in a lease analysis are evaluated on an after
tax basis, we should use the after
tax cost of borrowing. Previously, we were told the cost of debt, k d
was 10%. Therefore, we should discount cash flows at 6%. A
kd
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20-
Depreciation is a tax deductible expense, so it produces a tax savings of T(Depreciation). Year
Each maintenance payment of
is deductible so the after
tax cost of the lease is
The ending book value is
so the full
salvage (residual) value is taxed,
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Each lease payment of $ is deductible, so the after ‐ tax cost of the lease is ( ‐ T)($340) = ‐ $204. - PV cost of leasing (@6%) = ‐ $749.294. **0 1 2 3 4 A-T Lease pmt
-** Analysis in thousands:
20- Suppose there is a great deal of uncertainty regarding the computer’s residual value
Residual value could range from
to
and has an expected value of
To account for the risk introduced by an uncertain residual value, a higher discount rate should be used to discount the residual value.
Therefore, the cost of owning would be higher and leasing becomes even more attractive.
20-
A cancellation clause lowers the risk of the lease to the lessee. - However, it increases the risk to the lessor.
20-
Dividends are indexed to the rate on treasury securities instead of being fixed.
Excellent
corporate investment:
Only 30% of dividends are taxable to corporations. - The floating rate generally keeps issue trading near par. - However, if the issuer is risky, the floating rate preferred stock may have too much price instability for the liquid asset portfolios of many corporate investors.
20- How can a knowledge of call options help one understand warrants and convertibles?
A warrant is a long ‐ term call option. - A convertible bond consists of a fixed rate bond plus a call option.
20- What coupon rate should be set for this bond plus warrants package?
Step 1
Calculate the value of the bonds in the package V Package = V Bond + V Warrants = $1,000. V Warrants = 50($1.50) = $75. V Bond + $ = $1, V Bond = $925.
20- Calculating required annual coupon rate for bond with warrants package
Step
Find coupon payment and rate.
Solving for PMT, we have a solution of $110, which corresponds to an annual coupon rate of $ / $1, = 11%. INPUTSOUTPUT N I/YR PMT PV FV 20 12 110 1000 -
20-
Generally, a warrant will sell in the open market at a premium above its theoretical value (it can’t sell for less). - Therefore, warrants tend not to be exercised until just before they expire.
20-
In a stepped
up exercise price, the exercise price increases in steps over the warrant’s life. Because the value of the warrant falls when the exercise price is increased, step
up provisions encourage in
the
money warrant holders to exercise just prior to the step
up.
Since no dividends are earned on the warrant, holders will tend to exercise voluntarily if a stock’s dividend rises enough.