Mgmt 200 Spring 2011 Chapter 9

Mgmt 200 Spring 2011 Chapter 9 - Long-Term Liabilities...

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1 Long-Term Liabilities Chapter 9 Long-term liabilities • Bonds payable • Notes payable • Leases Pension • Pensions • Deferred taxes • Other Bonds Payable • Characteristics – Control – Interest is tax deductible Leverage effect – Default risk – Secured and Unsecured – Bond Indenture (Terms: Serial, Callable, Convertible) – Bond covenants (Restrictions on dividends, accounting ratios, etc)
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2 Bonds Payable • Terminology – Bond Principal (par value, face amount, maturity value) – Coupon rate (Stated rate, nominal rate) Bond price: 100 - sells at par, less than 100 – Bond price: 100 sells at par, less than 100 sells at a discount, greater than 100 – sells at a premium – Market interest rate (yield-to-maturity) – Market rate at the date of issuance is the effective-interest rate (accounting rate) 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? 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) 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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3 Exercise 9-3 On January 1, 2012, Frontier World issues $40 million of 8% bonds, due in 15 years, with interest payable semi-annually on June 30 and December 31 each year. The proceeds will be used to build a new ride that combines a roller coaster, a water ride, a dark tunnel, and the great smell of outdoor barbeque all in one ride. Required: 1.If the market rate is 7%, will the bonds issue at face amount, a discount, or a premium? Calculate the issue price. 2.If the market rate is 8%, will the bonds issue at face amount, a discount, or a premium? Calculate the issue price. 3.If the market rate is 9%, will the bonds issue at face amount, a discount, or a
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Mgmt 200 Spring 2011 Chapter 9 - Long-Term Liabilities...

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