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Unformatted text preview: CHAPTER 10 DISCUSSION QUESTIONS 1. Present values are less when discount rates are high as compared to when they are low. This is because the interest owed or the dis- count reported is proportionate to the in- terest rate. That is, a company cannot bor- row as much money on high-interest-paying loans as on low-interest-paying loans and yet could be required to pay the same peri- odic amount to satisfy the terms of the loan. 2. An annuity is a series of cash flows of equal amounts at equal time intervals. These cash flows can either be paid or received. 3. The stated amount of a liability equals its present value when the market rate of in- terest is equal to the stated rate of interest associated with the liability. For example, if a bank issues a two-year, $1,000, 8% note to a company when the market rate of in- terest is 8%, then the present value compu- tations will result in a present value of $1,000—the same as the face amount of the note. 4. A note payable is an obligation to pay a spe- cified sum of money on or before some fu- ture date, whereas a mortgage payable is a liability that is usually paid in periodic (monthly) installments. Also, a mortgage payable is usually secured by the asset that was purchased with the borrowed money. 5. For each mortgage payment, a portion is in- terest, and the remainder is applied to re- duce the principal. To compute that amount attributable to principal, the outstanding loan balance is multiplied by the monthly interest rate. The result is the interest portion of the payment. Subtracting this amount from the total payment gives the amount applied to reduce the principal. 6. Under a capital lease, the lease liability at the inception of the lease is the present value of the future annual lease payments discounted at the leasing company’s bor- rowing rate. In other words, the lease pay- ments include a principal element and an in- terest element. By discounting the lease payments, the present value is equal to the principal element of the transaction. 7. Companies prefer to classify leases as operating leases rather than as capital leases to reduce the amount of their re- ported liabilities. The economic obligation associated with an operating lease is not classified as a “liability” for accounting purposes, and thus is not included in the balance sheet. Because of this, operating leases are a form of “off-balance-sheet financing.” 8. Companies usually sell bonds through un- derwriters to individuals, other companies, pension funds, insurance companies, uni- versities, or other institutions that perceive bonds to be an attractive investment. Because bonds are usually sold in small de- nominations, almost anyone can buy them....
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This note was uploaded on 02/02/2010 for the course FNEC 140 taught by Professor Clark during the Spring '08 term at Vanderbilt.
- Spring '08