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Unformatted text preview: CHAPTER 9 Financing Activities THINKING BEYOND THE QUESTION What are the fundamental accounting issues associated with financing activities? Debt increases a companys financial risk. The debt and interest on the debt have to be paid by the borrower. If a company fails to make these payments when they are due, the company can be forced to seek protec- tion in bankruptcy and may be forced to liquidate its assets to repay the amounts owed. However, the use of debt can also increase return to a companys stockholders. If a company can borrow at 8%, for example, and earn 12% on the additional operations financed by its borrowing, it is earning an extra 4% for its stockholders. Managers analyze the trade-off between risk and return. That trade-off depends on many factors, includ- ing the volatility of a companys earnings and cash flows and manage- ments expectations about future earnings and growth potential. A com- pany with volatile earnings and cash flows runs a higher risk of being un- able to meet debt payments. A company with good growth opportunities can use debt to help finance that growth. QUESTIONS Q9-1 Liabilities are sometimes liquidated with resources other than cash, but it is cash that is most often used. Therefore, separation of liabilities into short-term and long-term categories distinguishes immediate needs for cash from those that are not so immediate. Once the more immediate needs for cash are identified, the reader of the balance sheet can assess the adequacy of short-term resources available to meet those cash needs. Failure to separate short-term liabilities from long-term liabilities would make such an assessment difficult. Q9-2 Debentures are unsecured bonds. This means there is no specific collateral backing for the bonds. Specific assets are not pledged as security. Instead, bondholders rely on the general credit worthiness of the company to back up the bonds. Serial bonds come due, a portion at a time, over a period of years. This is in contrast to bond issues in which all bonds come due for repayment at the same date. Callable bonds are bonds that a company can reacquire prior to their maturity date, after they have been outstanding for a specified period of time. 233 234 Chapter 9 Q9-3 The stated rate (nominal rate) is the interest rate that is printed on the face of the bond. When multiplied by the face value of the bond, it determines the amount of interest that will be paid to bondholders each period. The effective rate is the actual rate of return that is earned by a bondholder during the period. The stated rate and the effective rate are identical when the bond is acquired at face value. The stated rate differs from the effective rate whenever the bond is acquired at a price different from the face value....
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This note was uploaded on 06/18/2011 for the course ACC 300+ taught by Professor Gh during the Spring '11 term at Saint Joseph's University.
- Spring '11