Chapter 10

Chapter 10 - Chapter 10: Long Term Liabilities Long-term...

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Chapter 10: Long Term Liabilities
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Long-term liabilities Bonds payable Notes payable Leases Pensions Deferred taxes Other
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Bonds Payable Characteristics Control Interest is tax deductible Leverage effect Default risk Bond Indenture (Terms: Callable, convertible) Bond covenants (Restrictions on dividends, accounting ratios, etc)
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Bonds Payable Terminology Bond Principal (par value, face amount, maturity value) Coupon rate (Stated rate, nominal rate, stated rate) Bond price: 100 - sells at par, less than 100 – sells at a discount, greater than 100 – sells at a premium Market rate (yield-to-maturity) Market rate at the date of issuance is the effective- interest rate (accounting rate)
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Pricing Bonds You have the choice of investing in one of two bonds. Both bonds are sold in $1,000 face value lots. Both bonds mature in 12 months and the market rate of interest is 10%. The first bond has a coupon rate of 0%, while the second bond has a coupon rate of 100%. Which bond is the preferred investment?
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Pricing Bonds The price of the bonds is the present value of the bond cash flows discounted at the market rate of interest (required rate of return or yield). The bond cash flows are the face value to be received at maturity and the interest payments (face value x coupon rate). If coupon rate equals the market rate then the bond sells at par (price =100). If the coupon rate is less than the market rate then the bond sells at a discount (price less than 100). If the coupon rate is more than the market rate then the bond sells at a premium (price greater than 100).
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Exercise 10-2: Issue Price Youngblood Inc. plans to issue $500,000 face value bonds with a stated interest rate of 8%.They will mature in ten years. Interest will be paid semiannually. At the date of issuance, assume the market rate is (a) 8%, (b) 6%, and (c) 10%. Required For each market interest rate, answer the following questions: 1. What is the amount due at maturity? 2. How much interest expense will be accrue every six months? 3. At what price will the bond be issued?
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1. a. $500,000 b. $500,000 c. $500,000
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2. a. $500,000 × 8% × 1/2 year = $20,000 b. $500,000 × 6% × 1/2 year = $15,000 c. $500,000 × 10% × 1/2 year = $25,000
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3. a. $20,000 × 13.590 (Table 9-4, n = 20, i = 4%) = $271,800 $500,000 × 0.456 (Table 9-2, n = 20, i = 4%) = 228,000 Issue price $499,800 * *Should equal $500,000; the difference is due to rounding in present value factors. b. $20,000 × 14.877 (Table 9-4, n = 20, i = 3%) = $297,540 $500,000 × 0.554 (Table 9-2, n = 20, i = 3%) = 277,000 Issue price $574,540 c. $20,000 × 12.462 (Table 9-4, n = 20, i = 5%) = $249,240 $500,000 × 0.377 (Table 9-2, n = 20, i = 5%) = 188,500 Issue price $437,740
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Issuing Bonds at a discount The price of the bonds when issued is the present value of the bond cash flows discounted at the market rate of interest on the date of issue (effective interest rate). If the coupon rate is less than the market rate then the bond sells at a
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Chapter 10 - Chapter 10: Long Term Liabilities Long-term...

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