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CHAPTER 20 Hybrid Financing:
Preferred Stock, Leasing, Warrants, and Convertibles
Preferred stock Leasing
Warrants
Convertibles
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Leasing
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.
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Analysis: Lease vs. Borrow andbuy
Data:
New computer costs $1,200,000.
3year MACRS class life; 4year economic life. Tax rate = 40%.
kd = 10%.
Maintenance of $25,000/year, payable at beginning of each year.
Residual value in Year 4 of $125,000. 4year lease includes maintenance.
Lease payment is $340,000/year, payable at beginning of each year.
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Depreciation schedule
Depreciable basis = $1,200,000
MACRS Depreciation EndofYear Year Rate Expense Book Value
1 0.33 $ 396,000 2 0.45 540,000 3 0.15 180,000
4 0.07 84,000
$804,000 264,000
84,000
0
1.00 $1,200,000
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In a lease analysis, at what discount rate should cash flows be discounted?
Since cash flows in a lease analysis are evaluated on an aftertax basis, we should use the aftertax cost of borrowing.
Previously, we were told the cost of debt, kd, was 10%. Therefore, we should discount cash flows at 6%.
AT kd = 10%(1 – T) = 10%(1 – 0.4) = 6%.
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