long term liabilities. capital structure debt financing - bonds ◦ interest is tax deductible ...

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