Chapter 10 - Chapter 10 Characteristics of Bonds Payable...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 10 Characteristics of Bonds Payable Both bonds and stocks are issued by corporations to raise money for long-term purposes Why a corporation would issue a bound instead of stock: 1. Stockholders maintain control. Bondholders do not vote or share in the company’s earnings 2. Interest Expense is tax deductible. The tax deductibility of interest expense reduces the net cost of borrowing. This is an advantage compared to dividends paid on stock which are not tax deductible 3. The impact on earnings is positive. Money can often be borrowed at a low interest rate and invested at a higher rate. Assume that home video inc. owns a video rental store. The company has SE of 100,000 invested in the store and earns net income of 20,000 per year. Management plans to open a new store that will also cost 100,000 and earn 20,000 per year. The use of debt will increase the return to the owners Unfortunately bonds carry higher risk than equity Major disadvantages associated with issuing bonds 1. Risk of Bankruptcy. Interest payments to bondholders are fixed charges that must be paid each period whether the corporation earns income or incurs a loss. 2. Negative impact on cash flows. Debt must be repaid at a specified time in the future. Management must be able to generate sufficient cash to repay the debt or have the ability to refinance it. A bond usually requires the payment of interest over its life with repayment of principal on the maturity date The Bond Principle: is the amount (a) payable at the maturity of the bond and (b) on which the periodic cash interest payments are computed o Also called Par Value or Face Amount o Most individual par values is 1,000
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Stated Rate: is the rate of cash interest per period stated in the bond contract. Unsecured Bond (debenture): no assets are pledged as a guarantee of repayment at maturity. Secured Bond: specific assets are pledged as a guarantee of repayment at maturity Callable Bond: bond may be called for early retirement by the issuer Convertible Bond: Bond may be converted to common stock of the issuer Indenture: a bond contract that specifies the legal provisions of a bond issue o these provisions include the maturity date, rate of interest paid, date of each interest payment, and any conversion privileges. Also contains covenant designed to protect the creditors o Includes limitations on new debt that the company might issue in the future, limitations on the payment of dividends and required minimums of certain accounting ratios such as current ratio Bond issuer prepares prospectus which is a legal document that is given to potential bond investors--- tells about company etc. Bond Certificate:
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 02/02/2010 for the course BCOR 2000 at Colorado.

Page1 / 8

Chapter 10 - Chapter 10 Characteristics of Bonds Payable...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online