Financial Accounting Ch9 Detailed Summary PDF

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Debt Financing: Borrowing money from creditors (Liabilities) Equity Financing: Obtaining investment from stockholders (Stockholders’ equity) Capital Structure: Mixture of liabilities and stockholders’ equity in a business Interest Expense incurred when borrowing money is tax- deductible * Interest E...

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Chapter 9: Long-Term Liabilities Debt Financing: Borrowing money from creditors (Liabilities) Equity Financing: Obtaining investment from stockholders (Stockholders’ equity) Capital Structure: Mixture of liabilities and stockholders’ equity in a business * Interest Expense incurred when borrowing money is tax- deductible * * Interest Expense incurred when paying dividends to stockholders are not tax-deductible * Bonds: formal debt instrument that obligates the borrower to repay a stated amount (principal or face amount) at a specified maturity date.  Interest usually paid semiannually (begins 6 months after issuing date)  City needs external financing so it borrows from the community o Those investing will receive interest over the life of the bond and the repayment of face amount at the end of the bond’s life)  Bonds are sold (unwritten) by investment houses  Private placement: selling debt securities directly to single investor to keep costs down  Collateral: something pledged as security for repayment of a loan  Unsecured(debentures): secured full faith&credit  Sinking fund: i.e. borrowing $20 million due in 10 years. Put $2 million into sinking fund each year (so in 10 years money available)  Serial bonds: i.e. issuing $20 million made due at the of $2 million per year for (10yrs)  (redeemable) Callable protects borrower against future decreases in interest rates. If interest rates decline, borrower can buy back high interest rate bonds at a fixed price & issue new bonds at the new, lower interest rate  *Callable benefits borrower, convertible benefits both borrower and lender*  Convertible: i.e. $1000 convertible bonds can be converted to 20 shares of common stock. If market price of the common stock goes about $50 per share = bondholders benefit o If common stock goes to $60 per share, convertible bondholder can trade $1000 bond for 20 shares of $60/share (or $1200) o Borrower benefits (convertible bonds sell at a higher price & require lower interest rate than bonds without a conversion feature)

Company issues $100,000 bonds with 7% interest each year due in 10 years  Interest rate paid semiannually  1-year interest rate= 100,000 * 0.07= 7000 o ½ year interest rate= 7000 * 0.05 = 3,500  20 payments of 3,500 (10 years semi-annual 

Stated Interest Rate: rate quoted in the bond contract used to calculate cash payments for interest Market Interest Rate: True interest rate used by investors to value the bond issue (can be > < = stated 7%) Common Terms: Market rate is also known as “effective-interest rate” or “yield rate” *# of periods to maturity*= # of years to maturity * # of interest payments per year Annuity: Series of equal amounts over equal time periods Default Risk: possibility that a company will be unable to pay the bond’s face amount or interest as due - As a company’s default risk increases, investors demand HIGHER market interest rate on bond investment

Chapter 9: Long-Term Liabilities The HIGHER the market interest rate, the LOWER the bond issue price will be *Interest rate used to calculate bond issue price is ALWAYS market rate, NEVER stated rate *use stated to calculate interest payment each period BUT market rate to calculate present value of cash flows Bonds Issued at Face Amount (Par Bonds Issued at Discount Bond Issued at Premium - Stated interest rate: 7% - Stated Interest Rate: 7% - Stated Interest Rate: 7% - Market Interest Rate: 6% - Market Interest Rate: 7% - Market Interest Rate: 8% - Stated > Market= more attractive - Stated...