Chapter 18

Problem 3
Business Value 800,000 $
Total Current Shares 40000
Price/Share 20.00 $
Investment of 200000 @ $20/share
Angel Investment 200,000 $
Shares Sold to Investor 10,000
Problem 7
Input Data
Existing bond issue 75,000,000 $
Original Floatation cost 5,000,000 $
Maturity of original debt 30
Years since old debt issue 5
Call premium (%) 12%
Original coupon rate 12%
After-tax cost of new debt
Investment Outlay Before-Tax
Call Premium on old Bond (9,000,000) $
Flotation costs on new issue (5,000,000.00)
Immediate tax savings on old flotation cost expense 4,166,666.67
Extra interest paid on old issue (450,000.00)
Interest earned on short-term investment 225,000.00
Total after-tax investment (10,058,333) $
Annual Flotation Cost Tax Effects Before-Tax
Interest on old bond 200,000 $
Interest on new bond (166,666.67)
Net Savings 33,333 $
Annual Interest Savings Due to Refunding Before-Tax
Interest on old bond 9,000,000 $
Interest on new bond (7,500,000.00)
Net interest savings 1,500,000 $
Before-Tax
Annual Cash Flows 1,533,333 $
After Tax Interest Rate
NPV of Refund
New bond issue 75,000,000 $
New floatation cost 5,000,000 $
New bond maturity 25
New cost of debt 10%
Tax rate 40%
Short-term interest rate 6%
After-Tax
(5,400,000) $
(5,000,000.00)
1,666,666.67
(450,000.00)
225,000.00
(8,958,333) $
After-Tax
80,000 $
(66,666.67)
13,333 $
After-Tax
5,400,000 $
(4,500,000.00)
900,000 $
After-Tax
913,333 $
0.06
$2,717,131.96
Problem 7
Mullet Technologies is considering whether or not to refund a $75 million, 12%
coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $5
million of floatation costs on the 12% bonds over the issue's 30
Mullet's investment banks have indicated that the company could sell a new
25-year issue at an interest rate of 10% in today's market. Neither they nor
mullet's management anticipated that interest rates will fall below 10% any
time soon, but there is a chance that rates will increase.

A call premium of 12% would be required to retire the old bonds, and flotation
costs on the new issue would amount to $5 million. Mullet's marginal federal
plus-state tax rate is 40%. The new bonds would be issued 1 month before the
old bonds are called, with the proceeds being invested in short
government securities returning 6% annually during the interim period.

Conduct a complete bond refunding analysis. What is the bond refunding's
NPV?
Mullet Technologies is considering whether or not to refund a $75 million, 12%
year bond issue that was sold 5 years ago. It is amortizing $5
million of floatation costs on the 12% bonds over the issue's 30-year life.
Mullet's investment banks have indicated that the company could sell a new
year issue at an interest rate of 10% in today's market. Neither they nor
mullet's management anticipated that interest rates will fall below 10% any
time soon, but there is a chance that rates will increase.
A call premium of 12% would be required to retire the old bonds, and flotation
costs on the new issue would amount to $5 million. Mullet's marginal federal-
state tax rate is 40%. The new bonds would be issued 1 month before the
old bonds are called, with the proceeds being invested in short-term
government securities returning 6% annually during the interim period.
Conduct a complete bond refunding analysis. What is the bond refunding's
Problem 4
Problem Variables
NAL=PV Cost of Owning - PV Cost of Leasing
Tax Rate 40%
Loan Interest Rate 15%
Install Costs 1,500,000
Loan Value 1,500,000
After-tax Interest Rate(Loan) 9%
Residual Value 250,000
Lease Payments (400,000)
Year 3-Year Deprec.
1 0.3333 499,950 $
2 0.4445 666,750 $
3 0.1481 222,150 $
4 0.0741 111,150 $
Payment ($463,002.99)
PV Cost of Owning: 1 2
After-Tax Loan Payments ($463,002.99) ($463,002.99)
Deprec. Tax Savings 199,980 266,700
Residual Value
Tax on Residual Value
Net Cash Flow (263,021.99) $ (196,300.99) $
($241,304.58) ($165,222.62)
PV Cost of Owning: ($885,671.71)
PV Cost of Leasing: 1 2
Lease Payment (400,000) (400,000)
Tax Savings 160,000 160,000
Net Cash Flow (240,000) (240,000)
($220,183.49) ($202,003.20)
PV Cost of Owning: ($777,532.77)
Net Advantage Lease (NAL)
NAL=PV Cost of Owning - PV Cost of Leasing ($108,138.94)
Chapter 19
Year 3-Year
1 0.3333
2 0.4445
3 0.1481
4 0.0741
Deprec Tax Savings
199,980 $
266,700 $
88,860 $
44,460 $
3 4
($463,002.99) ($463,002.99)
88,860 44,460
250,000
(100,000)
(374,139.99) $ (268,538.99) $
($288,904.72) ($190,239.79)
3 4
(400,000) (400,000)
160,000 160,000
(240,000) (240,000)
($185,324.04) ($170,022.05)
MACRS 3-Year Class
Chapter 19
Problem 4
Big Sky Mining Company must install $1.5 Million of new
machinery in its Nevada mine. It can obtain a bank loan for
100% of the purchase price, or it can lease the machinery.
Assume that the following facts apply.

1-Machinery falls into MARCS 3-year class
2-Under either lease or purchase, Big Sky must pay for
insurance, property taxes, and maintenance
3-Firm's Tax rate is 40%
4-Loan would have an interest rate of 15%. It would be
nonamortizing, with only interest paid at the end of each
year for 4 years and the principal repaid at year 4.
5-Lease trms call for $400000 payments at the end of each of
the next 4 years.
6-Big Sky Mining has no use for machine beyond expiration
of lease and the machine has a a residual value of $250,000
at end of year 4.

Machine Cost -100000
Year 3-Year
MACRS 3-year 1 0.3333
3 year life 2 0.4445
Residual value after 3 years 30000 3 0.1481
After-tax Interest Rate(Loan) 0.08 4 0.0741
Lease
3 year lease -29000 Beginning
Lease Includes Maintenance
Tax 20%
Purchase
3 year loan
Interest paid at EOY
Before-Tax Cost 10%
Repaid A EO3Y -100000 End
Yearly Maintenance -3000 Beginning
Year 0 1 2 3
Lease
Cash Out Flow -29000 -29000 -29000
Tax Savings 5800 5800 5800
Net Cash Flow -23200 -23200 -23200
-23200 -21481.5 -19890.3
PV of Cost of Lease -64571.7
Purchase
Maintenance -3000 -3000 -3000
Loan Interest -10000 -10000 -10000
Repayment -100000
Tax Interest Savings 2000 2000 2000
Deprec Tax Savings 6666 8890 2962
Maint. Tax Savings 600 600 600
Residual Value 24000
Net Cash Flow -2400 -3734 -1510 -81038
-2400 -3457.41 -1294.58 -64330.6
PV of Cost Purchase -71482.6
Net Advantage Lease (NAL)
NAL=PV Cost of Owning - PV Cost of Leasing -6910.82
Chapter 19 Home Work - Handout Problem 6
MACRS 3-Year Class
Carmichael
machine that costs $100,000. The company is evaluating
whether it should lease or purchase the machine. The
equipment falls into the MACRS 3
would be used for 3 years and then sold, because the
firm plans to move to a new facility at that time. The
estimated value of the equipment after 3 years is
$30,000. A maintenance contract the equipment would
cost $3000 per year, payable at the beginning of each
year. Alternatively, the Firm could lease the equipment
for 3 years for a lease payment of $29000 per year,
payable at the beginning of each year. The lease would
include maintenance. The firm is in the 20% tax bracket,
and it could obtain a 3
payable at the end of the year, to purchase the
equipment
should be repaid at the end of the third year. If there is a
positive Net Advantage to Leasing the firm will lease the
equipment. Otherwise, it will buy it.
(Note: Assume MACRS rate for Year 1 to 4 are 0.3333,
.4445, .1481, and .0741.)

Deprec.
33330
44450
14810
7410
Carmichael Cleaners needs a new stream finishing
machine that costs $100,000. The company is evaluating
whether it should lease or purchase the machine. The
equipment falls into the MACRS 3-year class, and it
would be used for 3 years and then sold, because the
firm plans to move to a new facility at that time. The
estimated value of the equipment after 3 years is
$30,000. A maintenance contract the equipment would
cost $3000 per year, payable at the beginning of each
year. Alternatively, the Firm could lease the equipment
for 3 years for a lease payment of $29000 per year,
payable at the beginning of each year. The lease would
include maintenance. The firm is in the 20% tax bracket,
and it could obtain a 3-year simple interest loan, interest
payable at the end of the year, to purchase the
equipment at a before-tax cost of 10%; the $100,000
should be repaid at the end of the third year. If there is a
positive Net Advantage to Leasing the firm will lease the
equipment. Otherwise, it will buy it. What is the NAL?
(Note: Assume MACRS rate for Year 1 to 4 are 0.3333,
.4445, .1481, and .0741.)