lec15_debt - Accounting for Long-Term Debt 15.511 Corporate...

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1 Accounting for Long-Term Debt 15.511 Corporate Accounting Summer 2004 Professor S. P. Kothari Sloan School of Management Massachusetts Institute of Technology July 2, 2004
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2 Agenda – Long-Term Debt ± Extend our understanding of valuation methods beyond simple present value calculations. ± Understand the terminology of long-term debt ± Bonds – coupon and zero-coupon bonds ± At Par vs. Discount vs. Premium ± Market interest rate versus coupon rate ± Mortgages – Interest plus Principal paid each period ± Practice bookkeeping for debt issuance, interest accruals, periodic payments, and debt retirement. ± Understand how long-term debt affects financial statements over time.
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3 Bonds ± Bonds ± Periodic interest payments and face value due at maturity ± Face value (amount) ± (Principal) Amount due at maturity ± Interest payments ± Coupon rate times the face value of debt ± Coupon rate is the interest rate stated in the note. It’s used to calculate interest payments ± Market rate of interest ± The rate of interest demanded in the market place given the risk characteristics of a bond ± Can be higher or lower than the coupon rate
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4 Bonds ± Consider a loan with ± principal of $10,000 ± initiated on 1/1/01 ± The market interest rate is 6% ± Final payment is to be made at the end of the third year, i.e., on 12/31/03. ± What annual payments are required under the following three alternatives? ± Annual interest payment at the end of each year and repayment of principal at the end of the third year (typical bond terms). ± A single payment (of principal and interest) at the end of year 3 (Zero-Coupon bond). ± Three equal payments at the end of each year (mortgage / new car loan terms).
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5 Bonds - alternative payment streams Coupon Zero Mortgage End of Year 1 Int 0 Int + P End of Year 2 Int 0 Int + P End of Year 3 Int + P Int + P Int + P
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6 Accounting for a Bond issued at par Coupon Rate 6% = Market Rate 6% ± At the time of the bond issue ± Dr Cash 10,000 ± Cr Bond Payable 10,000 ± Periodically thereafter ± Cash interest payments = Face Value x Coupon rate ± Bond payable at the present value of cash flows, i.e., the present value of interest and principal ± Interest expense = Bond payable x market interest rate ± Difference between interest expense and cash interest payment is added to Bond Payable ± At maturity ± Pay interest and entire principal balance
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7 Accounting for a Bond issued at par Coupon Rate 6% = Market Rate 6% ± What is the present value of the bond? ± Payment stream ± Three annual coupon payments of $600 each ± Principal payment of $10,000 at the end of three years ± Present value ± PV of ordinary annuity, n = 3, r = 6%, Table 4 ± $600 x 2.67301 = $1603.81 ± PV of $10,000, n = 3, r = 6%, Table 2 ± $10,000 x 0.83962 = $8396.20 ± PV = $1603.81 + $8396.20 = $10,000
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8 Accounting for a Bond issued at par Coupon Rate 6% = Market Rate 6%
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lec15_debt - Accounting for Long-Term Debt 15.511 Corporate...

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