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Unformatted text preview: Solutions to Questions and Multiple Choice Questions 1. The two main sources of financing for a business are debt and equity. 2. 3. 4. 5. 6. . 7. 8. 9. 10. 11. The face value of a bond is also called the stated value or par value. 12. 13. 14. 15. A definitely determinable liability is one that can be measured exactly such as an account payable or a note payable. An estimated liability is a liability whose amount is not certain such as liabilities under a warranty agreement. The expense associated with a warranty is recognized at the point at which the inventory with which it is associated is sold. When the product needs to be repaired, the cost is offset against the liability. A mortgage is a long-term liability that gives the lender a claim against property if the borrower does not make payments. Installment loan payments reduce principal and interest expense is recorded. The balance in liabilities decreases on the balance sheet and the interest expense is reported on the income statement. Bonds are repaid with periodic payments of interest to the bondholders and with the principal amount repaid at the maturity date of the bond. Installment payments are part interest and part principal and occur every year or every month over the life of the loan. Advantages to issuing bonds include: the larger amount of money the company is able to borrow, the longer period of time of the loan, and the lower interest rate on the debt. The time value of money refers to the fact that money has value over time. That value is the interest that it can earn. Interest payments for a bond are calculated by multiplying the stated interest rate times the principal amount of the bond. The stated interest rate determines the cash payment of the bond. The effective interest rate is the market rate of interest that investors actually demand. A bond is issued at a discount when the stated rate is less than the market rate. A bond is issued at a premium when the stated rate is greater than the market rate. The carrying value of the bond is equal to the par value plus the unamortized premium or minus the unamortized discount. At maturity, the carrying value of the bond is equal to the par value. A convertible bond gives the bondholder the option of exchanging the bond for common stock. A callable bond may be retired prior to maturity at the option of the issuer for a specified amount of money. A zero coupon bond pays no interest during the life of the bond. A bond with a stated interest rate pays interest at that rate. 16. 17. 18. Capital structure refers to the relative amounts of debt and equity used to finance the firm. 19. Multiple Choice 1. a 2. a 3. b 4. b 5. b 6. a 7. a 8. b 9....
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