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CHAPTER 11 LONG-TERM LIABILITIES: NOTES, BONDS, AND LEASES BRIEF EXERCISES BE11–1 a. During 2003 Radio Shack paid down $20 million of the medium-term notes. At the same time during 2003 Radio Shack incurred a small amount of capital lease obligations. The balance sheet and the statement of cash flows were affected by these transactions. b. During 2003 approximately $10.425 million of interest expense was recognized on the 6.95% notes (6.95% x $150 million). c. If Radio Shack paid $30 million to retire the medium term notes in 2003 the company would have recorded a gain of $14.5 million on the transaction. ($44.5 – $30). This would be found on the income statement as a gain on the early extinguishment of debt. BE11–2 a. The life of these bonds is 20 years, from 1997 until 2017. b. The stated interest rate is 0%. c. The effective rate is 3.2%. (The present value is $968 million, while the future value of the single sum in 20 years is $1.8 billion.) d. Bonds typically are issued in amounts of $1,000, therefore Hewlett-Packard issued 1.8 million bonds with a total face value of $1.8 billion. BE11–3 a. The operating lease payments reduced the reported income for the period, reduced the assets on the balance sheet (payment of cash), and impacted the statement of cash flows by reducing the net income of SuperValu for the reporting period. By reducing net income these lease payments are a use of cash from operations. b. The interest portion of capital lease payments and the depreciation on the capitalized lease assets reduce reported net income statement for the period. They also impact the balance sheet by reducing both the assets and the liabilities on the balance sheet. For a capital lease the interest payments is cash from operations, principal reductions is financing and the depreciation has no impact on the statement of cash flows. c. The $120 million of operating leases is a form of off-balance sheet financing for SuperValu. Supervalu does not have to show these future liabilities on its balance sheet. These future contractual payments are disclosed in the footnotes. One of the advantages of this approach is that these liabilities are not used in the calculation of liquidity ratios. 1
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EXERCISES E11–1 a. Melrose Enterprises' debt/equity ratio is currently 1.25 [($200,000 + $300,000) ÷ $400,000]. The company's loan agreement specifies that debt can be twice the stockholders' equity. Consequently, the company's debt cannot exceed $800,000. Since Melrose Enterprises already has $500,000 in debt, the company can borrow an additional $300,000. b. By definition, Melrose Enterprises will settle its December 31, 2005 current liabilities sometime during 2006. The company will probably also incur new current liabilities as of December 31, 2006. Since no information is provided as to the expected amount of current liabilities as of December 31, 2006, a reasonable assumption is that these liabilities will remain at $200,000. Consequently, Melrose Enterprises would have total debt of $500,000 and total stockholders'
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