Question 21 (20 points)

a) Determine the annual interest rate of foregoing the cash discount under the credit term: 2/10, net 60. If the client pays on day 90, how much does it cost her on an annual basis? Briefly discuss one advantage and one disadvantage of stretching accounts payable.

b) Cray Research's 6 1/8%, 25-year convertible debentures (bonds) are of similar risk to non-convertibles yielding 9%. What is the pure (or straight) bond price of this convertible bond? If the conversion price is $84, what is the conversion ratio? If Cray's common shares are selling for $65 on the market, what is the conversion value of this convertible? What is its theoretical value?

c) At the time of issue, the Fannie Mae warrants had an exercise price of $44.25 and the firm's common stock price was $33 per share. Each warrant entitled the holder to 1 share by paying the exercise price. What was the intrinsic value of one warrant at this time? On February 24, 1989 (approximately 2 years prior to the expiration of the warrant), Fannie Mae's stock price was $59, what was the intrinsic value of one warrant at this time? Meanwhile, on the market, the warrant was trading at $19.375. What is the difference between the intrinsic value and the market price? What is the name for this difference?

d) ABC Inc. is considering a change in its cash-only policy. The new terms would be net one month. Based on the following information, determine if ABC should proceed or not. The required return is 2.5% per month.

Current Policy New Policy

Price per unit $73 $75

Cost per unit $38 $38

Unit sales per month 3,280 3,390