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Chapter 9

Chapter 9 . Long Term Liabilities. Two sources of Financing. Capital Structure Debt Financing - Bonds Interest is tax deductible Equity Financing - Stocks Dividends paid is not tax deductible. BONDS. Same as Note Payable Note is to one lender

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Chapter 9

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  1. Chapter 9 Long Term Liabilities

  2. Two sources of Financing • Capital Structure • Debt Financing - Bonds • Interest is tax deductible • Equity Financing - Stocks • Dividends paid is not tax deductible

  3. BONDS • 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

  4. BONDS Terminology • 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

  5. E 9-2 PG 445 • Bond terminology

  6. Pricing a Bond • 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

  7. 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.

  8. EXAMPLE – pricing a bond @ Face Value • $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

  9. Three Ways to Calcuate • 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)

  10. Calculator • FV= $100000 • PMT= 3,500 • I/yr = 3.5 • N = 20 • Press PV • BE 9-2 pg 443

  11. Journal Entry • Issue Bond • Cash 100000 • Bonds Pay 100000 • Pay Interest Expense • Interest Expense 3500 • Cash 3500

  12. EXAMPLE – pricing a bond @ at a discount (less than MV) • $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

  13. 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)

  14. Calculator • FV= $100000 • PMT= 3,500 • I/yr = 4.0 • N = 20 • Press PV • BE 9-3 pg 443

  15. Journal Entry- discount • 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

  16. Amortization Table • Date • Interest Paid (Cash) • Interest Expense • Increase in Carrying Value • Carrying Value • Pg 426

  17. EXAMPLE – pricing a bond @ at a Premium (more than MV) • $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

  18. 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)

  19. FV= $100000 • PMT= 3,500 • I/yr = 3.0 • N = 20 • Press PV • BE 9-4 pg 443

  20. Journal Entry - Premium • 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

  21. AMORTIZATION TABLE • Date • Interest Paid (Cash) • Interest Expense • Increase in Carrying Value • Carrying Value • Pg 428

  22. Paying Back Bond • At Maturity • Bond Payable 100000 • Cash 100000 • Before Maturity -premium • Bond Payable 93670 • Loss 13207 • Cash 106877

  23. Mortgages ( Installment Debt) • Fixed Payment • Interest (Rate* principle) • Difference (reduction in principle) • Get Mortgage • Cash • M/P • Make a Payment • Principle • Interest Expense • Cash

  24. Amortization Table • See page 433 • BE 9-17 pg 444

  25. LEASES • 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

  26. Debt Analysis • 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

  27. Homework • Problems A • 9-1, 9-2, 9-4, 9-6, 9-7A

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