Assignment Questions -
Question 1 - Lease versus purchase
JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 40% tax bracket, and its after-tax cost of debt is currently 8%. The terms of the lease and of the purchase are as follows:
Lease - Annual end-of-year lease payments of $25,200 are required over the 3-year life of the lease. All maintenance costs will be paid by the lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $5,000 at termination of the lease.
Purchase - The research equipment, costing $60,000, can be financed entirely with a 14% loan requiring annual end-of-year payments of $25,844 for 3 years. The firm in this case will depreciate the equipment under MACRS using a 3-year recovery period. The firm will pay $1,800 per year for a service contract that covers all maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its 3-year recovery period.
a. Calculate the after-tax cash outflows associated with each alternative.
b. Calculate the present value of each cash outflow stream, using the after-tax cost of debt.
c. Which alternative-lease or purchase-would you recommend? Why?
Question 2 - Conversion (or stock) value
What is the conversion (or stock) value of each of the following convertible bonds?
a. A $1,000-par-value bond that is convertible into 25 shares of common stock. The common stock is currently selling for $50 per share.
b. A $1,000-par-value bond that is convertible into 12.5 shares of common stock. The common stock is currently selling for $42 per share.
c. $1,000-par-value bond that is convertible into 100 shares of common stock. The common stock is currently selling for $10.50 per share.
Question 3 - Tax effects of acquisition
Connors Shoe Company is contemplating the acquisition of Salinas Boots, a firm that has shown large operating tax losses over the past few years. As a result of the acquisition, Connors believes that the total pretax profits the merger will not change from their present level for 15 years. The tax loss c forward of Salinas is $800,000, and Connors projects that its annual earnings taxes will be $280,000 per year for each of the next 15 years. These earnings o sunned to fall within the annual limit legally allowed for application of the tax carry-forward resulting from the proposed merger. The firm is in the 40% tax bracket.
a. If Connors does not make the acquisition, what will be the company's tax it and earnings after taxes each year over the next 15 years?
b. If the acquisition is made, what will be the company's tax liability and earnings after taxes each year over the next 15 years?
c. If Salinas can be acquired for $350,000 in cash, should Connors make the acquisition, judging on the basis of tax considerations? (Ignore present value.)
Question 4 - EPS and postmerger price
Data for Henry Company and Mayer Services are given in the following table. Henry Company is considering merging with Mayer by swapping 1.25 shares of its stock for each share of Mayer stock. Henry Company expects its stock to sell at the same price/earnings (P/E) multiple after the merger as before merging.
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Item
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Henry Company
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Mayer Services
|
|
Earnings available for common stock
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$225,000
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$50,000
|
|
Number of shares of common stock outstanding
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90,000
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15,000
|
|
Market price per share
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$45
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$50
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a. Calculate the ratio of exchange in market price.
b. Calculate the earnings per share (EPS) and price/earnings (P/E) ratio for each company.
c. Calculate the price/earnings (P/E) ratio used to purchase Mayer Services.
d. Calculate the post-merger earnings per share (EPS) for Henry Company.
e. Calculate the expected market price per share of the merged firm. Discuss this result in light of your findings in part a.
Question 5 - ETHICS PROBLEM
Is there a conflict between maximizing shareholder wealth and never paying bribes when doing business abroad? If so, how might you explain the firm's position to shareholders asking why the company does not pay bribes when its foreign competitors in various nations clearly do so?
As the financial manager for a large multinational corporation (MNC), you have been asked to assess the firm's economic exposure. The two major currencies, other than the U.S. dollar, that affect the company are the Mexican peso (MP) and the British pound (£). You have been given the projected future cash flows for next year:
|
Currency
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Total inflow
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Total outflow
|
|
British pounds
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£17,000,000
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£11,000,000
|
|
Mexican pesos
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MP 100,000,000
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MP 25,000,000
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The current expected exchange rate in U.S. dollars with respect to the two currencies is as follows:
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Currency
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Exchange rate
|
|
British pounds
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$1.66
|
|
Mexican pesos
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$0.10
|
Assume that the movements in the Mexican peso and the British pound are highly correlated. Create a spreadsheet to answer the following questions.
a. Determine the net cash flows for both the Mexican peso and the British pound.
b. Determine the net cash flow as measured in U.S. dollars. It will represent the value of the economic exposure.
c. Provide your assessment as to the company's degree of economic exposure. In other words, is it high or low based on your findings in part b?
Question 6 - Tax credits
A U.S.-based MNC has a foreign subsidiary that earns $250,000 before local taxes, with all the after-tax funds to be available to the parent in the form of dividends. The applicable taxes consist of a 33% foreign income tax rate, a foreign dividend withholding tax rate of 9%, and a U.S. tax rate of 34%. Calculate the net funds available to the parent MNC if:
a. Foreign taxes can be applied as a credit against the MNG's U.S. tax liability.
b. No tax credits are allowed.