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Basic Question 1 of 4

The bond indenture specifies that the 8% issue due June 2017 of Canton Corp. is redeemable in the event of a merger at par value. The bond is callable after December 31, 2012 at 103. In the event of a merger between Canton Corp and a suitor company owners of this issue will receive

A. the market price
B. par value
C. 103% of par value

User Contributed Comments 7

User Comment
stranger a. high effective rates means borrowing is expensive and PV of capital lease is lower: firm wud use CL b. firm wud use: better option than borrowing c. less debt: firm wud add CL, adding some more debt d. THIS IS UNFAVORABLE HENCE FIRM WUD NOT USE CL
kalps High effective tax rate means that operating lease payments would reduce profits and therefore tax - which is also positive.

However the answer is also correct in that gearing will increase with higher debt as the capital lease is effectively put on the balance sheet as debt
Gina why does a high effective tax rate increase the cost of borrowing?
mtcfa My take on the high effective tax rates is that a firm would prefer a capital lease because, in addittion to the interest expense, the firm can also deduct depreciation, and at least save in taxes in the early years. I'm not sure it has anything to do with the cost of borrowing.
gill15 High effective tax rates --- What does this mean? We want low Pretax Income to be taxed. How do we accomplish this? We would want own the items and have them depreciate ---

High effective tax rates --- want depreciation X to lower our profits --- need a capital lease.
gill15 Also from the borrowers end -- High effective tax rate would mean high borrowing from the bank, so get a capital lease from the lessor at a lower rate.
Shaan23 What I didnt understand was who the firm is(Lessee or the Lessor). Depending on who it is the answer is different.
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I am using your study notes and I know of at least 5 other friends of mine who used it and passed the exam last Dec. Keep up your great work!
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Learning Outcome Statements

identify financial reporting choices and biases that affect the quality and comparability of companies' financial statements and explain how such biases may affect financial decisions;

evaluate the quality of a company's financial data and recommend appropriate adjustments to improve quality and comparability with similar companies, including adjustments for differences in accounting standards, methods, and assumptions;

evaluate how a given change in accounting standards, methods, or assumptions affects financial statements and ratios;

analyze and interpret how balance sheet modifications, earnings normalization, and cash flow statement related modifications affect a company's financial statements, financial ratios, and overall financial condition.

CFA® 2024 Level II Curriculum, Volume 2, Module 16.