P17–4 Lease versus purchase JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 21% 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. (See Table 4.2for the applicable depreciation percentages.) 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.
  1. Calculate the after-taxcash outflows associated with each alternative.
  2. Calculate the present value of each cash outflow stream, using the after-taxcost of debt.
  3. Which alternative—lease or purchase—would you recommend? Why?

P17–10 Conversion (or stock) value What is the conversion (or stock) value of each of the following convertible bonds?

  1. 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.
  2. 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.
  3. A $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.

P18–11 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.

Item Henry Company Mayer Services
Earnings available for common stock $225,000 $50,000
Number of shares of common stock outstanding    90,000   15,000
Market price per share        $45       $50
  1. Calculate the ratio of exchange in market price.
  2. Calculate the earnings per share (EPS) and price/earnings (P/E) ratio for each company.
  3. Calculate the price/earnings (P/E) ratio used to purchase Mayer Services.
  4. Calculate the postmerger earnings per share (EPS) for Henry Company.
  5. Calculate the expected market price per share of the merged firm. Discuss this result in light of your findings in part

P19–6 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 who are asking why the company does not pay bribes when its foreign competitors in various nations clearly do so?

Corporate Finance