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[solutions manual] Corporate Finance 4th Global edition

(Berk) - Chapter 15
Corporate Finance (University of Queensland)

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Cha
pte
r15 De
btFi
nanc
ing 181

Chapt
er15
De
btFi
nanc
ing

No
te: Al
lpr
obl
emsinthischa
p tera
reav
ail
abl
einMyFi
nanc
eLa
b.Ana
ste
ris
k(*)i
ndi
cat
espr
obl
ems
wi
thahi
ghe
rlev
e lofdi
ffic
ult
y.

1 an:Comput
.Pl eth
ecl
osi
ngf
eesa
ndde
ter
minet
hepr
oce
edsf
romt
hel
oan.

Ex
ecut
e:
Fe
es:200,
00 0002400
. 0
To
talPr
oceeds:20
0,000 4000$196
,000

Ev
alua
te:Youwi
llr
ece
ive$196
,000a
fte
rpa
yin
gthec
los
ingf
eeony
our$200,
000l
oan
.

2
.a.Wit
hf ee
sof2%,y ourne
tis98% ofthel
oana
mountf
ort
hefir
stop
tion:0.98
(500,
000)=
490,
000;wit
hfeesof1%,yournetis99%oft
hel
oanamountf
orthesecondopti
on:
0.
99(500,
000)=495,000
.

b
.Be ca
u seyoupayint
erestonthegros
sloanamount(t
hepri
ncipaloftheloan),youri
nte
res
t
one achop t
ioni
scal
c ul
atedbase
don$500 ,
000.Fort
hefir
stopti
on, youint
eresti
s(0.
04)
(500,000)=20 ,
000,butyouonlyrece
ive
d490,000,s
oyourtruerateo fi
nter
estis
20,000/490,
000=0.0408 ,or4.
08%.

Forthesecondopti
on,youri
nte
res
tis(0.
045
)(500
,000
)=22,
500
,soy
ourt
ruer
ateo
f
int
eres
tis22,500
/495,
000=0 .
0455,or4.
55%

3 an:Comput
.Pl eth
efe
esa
ndt
hene
tpr
oce
edsy
ouwi
llr
ece
ivef
romt
hebondoffe
rin
g.

Ex
ecut
e:
Fe
es:100,
000,000
0 .033,000
,000
To
talPr
ocee :1
ds 00,
000,
000 3
,000
,000$
97,
000
,00
0

Ev
alua
te:Youwi
llr
ece
ive$97
,000,
000f
romt
hebondoffe
rin
g.

4. The U.S. government uses treasury bills, note, bonds, and TIPS. Treasury bills are pure
discount bonds with maturities of one year or less. Treasury notes are coupon bonds with semi-
annual coupon payments with maturities between 1 and 10 years. Treasury bonds are semi-
annual coupon bonds with maturities longer than 10 years. Finally, TIPS are bonds with coupon
payments that adjust with the rate of inflation. The final payment is protected against deflation

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182 Be
rk/
DeMa
rzo/
Har
for
d •
 Fun
dame
ntal
sofCor
por
ateFi
nanc
e,Four
thEdi
ti
on,
Globa
lEdi
ti
on

because the value of the final payment is the maximum between the face value and the inflation
adjusted face value.

317
5. The CPI index appreciated by  1 25.8%.
252
Consequently, the principal amount of the bond increased by this amount; that is, the original
face value of $1,000 increased to $1,258 (principal payment)
Since the bond pays semi-annual coupons, the coupon payment is
 4% 
(1.258)   ($1,000) $25.16.
 2 
The total principal + coupon payment on January 15, 2018 is $1,283.10.

279
6. The CPI index depreciated by 0.677
412
Consequently, the principal amount of the bond decreased by this amount; that is, the original
face value of $1,000 decreased to $677.
Because the bond pays semi-annual coupons, the coupon payment is:
 0.07 
0.677   $1,000 $23.695
 2 
However, the final payment of the maturity (i.e., the principal) is protected against deflation. So
since $677 is less than the original face value of $1,000, the original mount is repaid, i.e.,
$1,000.

7. Holders of the GNMA securities face payment risk because homeowners have the option to
prepay their debt whenever they decide to do so. In particular, they will prepay if interest rates
fall and they can obtain new debt at a lower interest rate. This is precisely when the holders of
GNMA securities would like to avoid payments because they can only reinvest at a lower
interest rate.

8. The distinguishing feature is that income from municipal bonds is not taxed at the federal level.

9. Plan:Youhaveposi
ti
vee
arni
ngs(ne
tincome),s
owithouta
nyquic
kra
tior
equi
rement
,you
couldpayupto$70.
2mil
li
onindivi
dends.Howeve
r,youmustc
heckt
hequi
ckrati
oaswel
l.
Currentas
ses c
t ah r
s ece
ivabl
es i
nvent
ory.

Exec
ute:
Cur
renta
sses $10
t .3mill
ion $8.
2mill
ion $4.8mil
lon $23.
i 3mi
ll
ion
Qui
ckrat
io (c
urrentas
ses i
t n
vent
ory
)/cur
rentli
abi
li
ti
es (
$23.3mil
lon $4.
i 8mi
ll
ion)
/
$18
.6mill
ion $18.5mil
li
on/$18.
6mill
ion 0.9946

Inordert
opa ydivi
dends
,youmus tr
ais
ey ourq u
ickrati
oto1;2,whic
hme a
nsyourcur
rent
ass
etsnetofinve
ntorymustbe1.2ti
mesyou rc urr
entli
abil
it
ie
s( 1.
2×18.6=22.
32).Soyou
mustincr
easeyourc a
shhol
dingstomeettheq uickrat
iotes
t.With$10.
3+(2232 18
. .
5)=
14.
12mi ll
ioninc a
shins
tea
dof$10 .
3mi l
lion,therat
iois:
(
14.
12mi
ll
ion+8
.2mi
ll
ion
)/$18.
6mi
ll
ion 1.
2

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Cha
pte
r15 De
btFi
nanc
ing 183

Thus,t
hema xi
mumdi vi
dendwou l
dbe$70.
2mi l
lon $
i (
14.12 10.
3)mi l
lion=$66.
38
mill
ion
.
Evaluat
e:Thequi
ckra t
iore
quir
ementf
orce
dy outousesomeofy ournetincometoi
ncr
eas
e
yourcas
hholdi
ngs
,thusreduci
ngthet
ota
learn
ingsav
aila
b l
etopa ydi
vidends.

10. Thenewfirm willhaveaNTAt ode btrati

othatisawe i
ghteda ver
ageoftherat
iosofyourfir
m
andthefir
my oua r
ea cq
uiring.Thewe ight
sa r
ey ourrelat
ivesi z
es.Becauseyouare2.1ti
me s
thesi
zeoftheotherfir
m, youwi l
lha veawe i
ghto f21/31,a nditwillhav
eawe ightof10/
31i n
thenewfirm.Ther a
tioforthecombi nedfir
mwi llbe( 21/31)(2.
1)+( 10/
31 )
(1.
2)=1.8096<
1.7,s
oyouc anacquirethefir
m withoutviolat
ingy ourcov e
na nt.

11 an:Cr
.a.Pl eat
eat
ime
li
neo
fth
eca
shflo
wsa
ndc
omput
etheyi
el
dtoma
tur
it
y.
Exe
cut e
:
Ti
me l
ine:
Time 0 1 2 9 10

Ca
shFl
ows $6 $6 $6 $100
$6
Thepr
ese
ntv
aluef
ormul
atoes
olv
edi
s:

6  1  100
102  1 0

YTM  ( 1 YTM)  (
1
1 YTM)10

Us
ingt
hea
nnui
tyc
alc
ula
to:YTM  5.
r 73%
N I
/Y PV PMT FV Ex
celFor
mul
a
Gi
ven: 10 102
.00 6 100
Sol
vef
orRate: 5.732% RATE(
10,
6102
, ,100)
Eval
uat
e:Theyie
ldt
oma
turit
yis5.
73%.

an:Cr
b.Pl eat
eat
ime
li
neoft
hec
ashflo
wsa
ndc
omput
eth
eyi
el
dtoc
all
.
Exe
c ute:YTC:
Ti
me li
ne:
Time 0 1

Ca
shFl
ows $100
$6

Thepr
ese
ntv
aluef
ormul
atob
eso
lve
dis
:

106 10
6
102  YTC  13.
92%
1 YTC 10
2

Ev
alua
te:Theyi
el
dtoc
alli
s3.
92%.

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184 Be
rk/
DeMa
rzo/
Har
for
d •
 Fun
dame
ntal
sofCor
por
ateFi
nanc
e,Four
thEdi
ti
on,
Globa
lEdi
ti
on

.Be
c c
aus
ethebondi
str
adi
nga
tapr
emi
um,
thel
ike
li
hoodofc
alli
shi
gh,a
ndt
heyi
el
dto
wor
sti
stheYTC:3.
92%.

12 an:Cr
.a.Pl eat
eat
ime
li
neo
fth
eca
shflo
wsa
ndc
omput
etheyi
el
dtoma
tur
it
y.
Ex
ecut
e:
Ti
mel
ine
:
Yea
rs 0 1 2 3
Pe
riods 0 1 2 3 4 5 6

Ca
shFl
ows $2.
35 $2.
35 $2.
35 $2
.35 $2.
35 $100
$2
.35
Thepr
ese
ntv
aluef
ormul
atobeso
lve
dis:
2.35  1  100
99.18  1  6 

i  (1  i )  (1  i)6
Us
ingt
hea
nnui
tyc
alc
ula
tor
:

i 2.498%

N I
/Y PV PMT FV Ex
celFo
rmul
a
Gi
ven: 6 99
.18 2
.35 100
RATE(
6,2
. 99.
35, 18,
1
Sol
vef
orRa
te: 2
.498% 00)

So
,be
caus
eYTM a
req
uot
eda
sAPRs
:

YTM i 2 2.498% 2 4.996%

Ev
alua
te:Theyi
el
dtoma
tur
it
yont
hebondi
s4.
996
%.
an:Cr
b.Pl eat
eat
ime
li
neoft
hecas
hflo
wsa
ndc
omput
eth
eyi
el
dtoc
all
.
Exe
cute:YTC:
Ti
meli
ne:
Year
s 0 1 2
Per
iods 0 1 2 3 4

Ca
shFl
ows $2
.35 $2.
35 $2
.35 $100
$2.
35
Thepr
ese
ntv
aluef
ormul
atob
eso
lve
dis
:

2.35  1  100
99.18  1  4 

i  (1  i)  (1  i)4

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Cha
pte
r15 De
btFi
nanc
ing 185

Us
ingt
hea
nnui
tyc
alc
ula
tor
:

i 2.568%

N I
/Y PV PMT FV Ex
celFor
mul
a
Gi
ven: 4 99.
18 2
.35 100
RATE(
4,2
. 99.
35, 18,
Sol
vef
orRa
te: 2.
568% 100)

Be
caus
eYTM (
andt
her
efor
eYTC)a
req
uot
eda
sAPRs
:

YTC i 2 5.568 2 5.136%%

Ev
alua
te:Theyi
el
dtoc
alli
s5.
136%.

.Be
c ca
uset
hebondist
radi
nga
tad
isc
ount
,thel
ike
li
hoodofc
alli
slo
w,a
ndt
hey
iel
dtowo
rst
i
stheYTM:4.996%.

13 an:Comput
.Pl eth
econ
ver
sionr
ati
ooft
hebond
.

Exec
ute:Thec
onv
ers
ionpr
icei
sth
efa
cev
alueo
fthebonddi
vide
dbyt
hec
onv
ers
ionr
ati
o.I
n
t
hisca
se:

Face value
P
Conversion ratio
$1,000

425
P $2.35

Ev
alua
te:Thec
onv
ers
ionr
ati
ofort
hisbondi
s$2
.35.

14
.Pl an:Thec onv
ersi
onrat
iogi
vesthenumberofs
haresr
ecei
vedinconve
rsi
on.Youcancal
cula
te
thebene
fitofconve
rsi
onbymultipl
yin
gthenumberofsha
resbythepri
cepershar
e.Thebene
fit
mustexceedthecost
,whichi
sgivin
gupthebondaswellaspa
yingthet
rans
acti
oncost
sof
2.7%.

Ex
ecut
e:

Numbe
rofs
har
esr
ece
ivd 48
e

To
talc
ostofc
onv
ers
ion $1
,000 1
.027 $1
,027

Re
qui
redpr
icep
ers
hae $1
r , 48 $21.
027/ 39

Eval
uat
e:Ifthepr
icepe
rsharei
s$21 .
39,y
ouarejus
tindi
ffe
rentt
oconver
ti
ng.Atan
yprice
abov
e$21.
39,youge
tagrea
terbe
nefitt
hanthec
ostofconv
e r
ti
ng,soyoupre
fert
oconve
rt.

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186 Be
rk/
DeMa
rzo/
Har
for
d •
 Fun
dame
ntal
sofCor
por
ateFi
nanc
e,Four
thEdi
ti
on,
Globa
lEdi
ti
on

15
.I tha
stomakesensef
oryoutotak
eabondwi t
hafaceval
ueof$1,000a
ndconv
erti
tint
osha
res
wort
h$35,s
oy ouneedt
oe xpe
cttog
etatl
east$1
,000/$35=28.57shar
es.
Thesmal
les
twhole
numberc
onver
sionra
ti
othatmakesc
onver
sionse
nsibl
eis29
.

16
.Plan:Accor
din
gtoTable15.
7,i
fconve
rte
d,e
achbondi
sworth107.
565sha
resof
Re
alNet
worksst
ock,a
ndthecal
lpr
icei
s100% off
acev
alueoft
hebond.

Theva
lueo
ftheshare
sper$1,
000ist
hen107.
565×thesh
arepri
ce.
Thebondhol
der
swi
ll
con
ver
twhenthebondisc
all
edift
heval
ueofconv
ers
ionexc
eedst
heca
llpr
ice.

Exe
cute:
a.At$6.74persh
a r
e,th
ev a
luetobondhol
der
sper$1,0
00b o
ndis(10
7.56) (
5 6.7
4)
$1,
043.38.
b.Thecallpri
ceis100% offac
ev a
lue,s
oiti
s$1,000.
c.Bondholder
swillconve
rtint
oshare
sifyoucal
lthebonds,a
stheval
ueofc
onver
ti
ngi
s
gre
atertha
nthev a
luerece
ivedundert
hecal
l.

Eval
uate:Bycall
ingthebonds
,Real
Networkscanf
orceconv
ers
ion—me a
nin
gthatt
heonl
y
ra
ti
onalthi
ngforbondhol
derst
odoisconve
r t
.Thus
,rat
hert
hanhavi
ngtopaybac
kthebonds
,
Real
Networkswil
lbea bl
etois
suene
ws har
e st
othebondho
lder
sins
tea
d.

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ars
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onLt
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