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Chapter 9
Long Term Liabilities
Capital Structure
Debt Financing - Bonds◦ Interest is tax deductible
Equity Financing - Stocks◦ Dividends paid is not tax deductible
Two sources of Financing
Same as Note Payable Note is to one lender Bonds are to several lenders Interest is paid every 6 months – twice a
year Usually 20 plus years Bonds sold for capital expenditures Sold to the public or to Large banks
(underwrite) for a fee
BONDS
Indenture – characteristics of bond Principle – Face Amount Interest - paid over life of the bond Sinking Fund- payments of principle to acct Secured or unsecured (debentures) Term or serial – all at once or installments Callable (redeemable)– borrower can call it
back Convertible – lender can change it to stock
BONDS Terminology
Bond terminology
E 9-2 PG 445
Issue Price of Bond◦ Present Value of Principle (Face Amount) $1◦ plus◦ Present Value of Interest payments $1 Annuity◦ When interest is paid semi annual interest rate is
half and time is double◦ Use the same time and % for both principle and
interest◦ Market Interest Rate is how to rate the value of
the bond◦ Stated Interest Rate is what you use for interest
payment and is stated on the bond
Pricing a Bond
The higher the market interest rate, the lower the bond issue price will be.
The lower the market interest rate, the higher the bond issue price will be.
$100,000 bond issued, 10 years, Stated Interest 7%, Market Interest 7%
(same)
Face Amount $100,000 Interest Payments-6months 3,500 Market Interest (7%/2) 3.5% Number of Periods (10yrs X2) 20periods
EXAMPLE – pricing a bond @ Face Value
Table : Face Value * multiplier $1 3.5% and 20 periods Interest Payment * $1 annuity 3.5% and 20
periods $100000 * .05257 = 50257
$3,500 * 14.2124= 49743 Issue Price 100000
Excel: PV(Market%,#periods,Interest payment, Face
amount,0) PV(.035,20,3500,100000,0)
Three Ways to Calcuate
FV= $100000 PMT= 3,500 I/yr = 3.5 N = 20
Press PV
BE 9-2 pg 443
Calculator
Issue Bond Cash 100000 Bonds Pay 100000
Pay Interest Expense Interest Expense 3500
Cash 3500
Journal Entry
$100,000 bond issued, 10 years, Stated Interest 7%, Market Interest 8%
Face Amount $100,000 Interest Payments-6months 3,500 Market Interest (8%/2) 4.0% Number of Periods (10yrs X2) 20periods
EXAMPLE – pricing a bond @ at a discount (less than MV)
Table : Face Value * multiplier $1 4.0% and 20 periods Interest Payment * $1 annuity 4.0% and 20
periods $100000 * .045639 = 45639
$3,500 * 13.59033 = 47566 Issue Price 93205
Excel: PV(Market%,#periods,Interest payment, Face
amount,0) PV(.04,20,3500,100000,0)
FV= $100000 PMT= 3,500 I/yr = 4.0 N = 20
Press PV
BE 9-3 pg 443
Calculator
Issue Bond Cash 93205 Bonds Pay 93295
Pay Interest Expense ( 1st 6 months) Interest Expense 3728 (93205*4%) Bonds Payable 228 Cash 3500
Pay Interest Expense (2nd 6 months) Interest Expense 3737 (93205+228*4%) Bonds Payable 237 Cash 3500
Journal Entry- discount
Date Interest Paid (Cash) Interest Expense Increase in Carrying Value Carrying Value Pg 426
Amortization Table
$100,000 bond issued, 10 years, Stated Interest 7%, Market Interest 6%
Face Amount $100,000 Interest Payments-6months 3,500 Market Interest (6%/2) 3.0% Number of Periods (10yrs X2) 20periods
EXAMPLE – pricing a bond @ at a Premium (more than MV)
Table : Face Value * multiplier $1 3.0% and 20 periods Interest Payment * $1 annuity 3.0% and 20
periods $100000 * .55368 = 55368
$3,500 * 14.87747 = 52071 Issue Price 107,439
Excel: PV(Market%,#periods,Interest payment, Face
amount,0) PV(.03,20,3500,100000,0)
FV= $100000 PMT= 3,500 I/yr = 3.0 N = 20
Press PV
BE 9-4 pg 443
Issue Bond Cash 107439 Bonds Pay 107439
Pay Interest Expense ( 1st 6 months) Interest Expense 3223 (107439*3%) Bonds Payable 277 Cash 3500
Pay Interest Expense (2nd 6 months) Interest Expense 3215 (107439-285*3%) Bonds Payable 285 Cash 3500
Journal Entry - Premium
Date Interest Paid (Cash) Interest Expense Increase in Carrying Value Carrying Value Pg 428
AMORTIZATION TABLE
At Maturity Bond Payable 100000 Cash 100000 Before Maturity -premium Bond Payable 93670 Loss 13207 Cash 106877
Paying Back Bond
Fixed Payment Interest (Rate* principle) Difference (reduction in principle)
Get Mortgage Cash
M/P Make a Payment
◦ Principle◦ Interest Expense◦ Cash
Mortgages ( Installment Debt)
See page 433 BE 9-17 pg 444
Amortization Table
Lessee --User Lessor --Owner
Lease Contractual agreement for the right to use the asset for a specified time
Operating Leases – rentals Capital Leases – buying a capital asset
LEASES
Debt to Equity Total Liabilities/ Total SE Measure of financial leverage Return on Assets Net Income/Avg Total Assets
◦ Overall profitability Return on Equity Net Income/Avg Total SE
ability to generate earnings from resources that owners provide
Times Interest Earned Net Income+InterestX+Tax X/Interest X Compares interest expense to net income available to pay interest expense
BE 9-18 pg 444
Debt Analysis
Problems A 9-1, 9-2, 9-4, 9-6, 9-7A
Homework