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ch16 - CHAPTER 16 Long-Term Liabilities ANSWERS TO...

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CHAPTER 16 Long-Term Liabilities ANSWERS TO QUESTIONS 1. (a) Long-term liabilities are obligations that are expected to be paid after one year. Examples include bonds, long-term notes, and lease obligations. (b) Bonds are a form of interest-bearing notes payable used by corporations, universities, and governmental agencies. 2. (a) The major advantages are: (1) Stockholder control is not affected—bondholders do not have voting rights, so current stockholders retain full control over the company. (2) Tax savings result—bond interest is deductible for tax purposes; dividends on stock are not. (3) Earnings per share on common stock may be higher—although bond interest expense will reduce net income, earnings per share on common stock will often be higher under bond financing because no additional shares of common stock are issued. (b) The major disadvantages in using bonds are that interest must be paid on a periodic basis and the principal (face value) of the bonds must be paid at maturity. 3. (a) Secured bonds have specific assets of the issuer pledged as collateral. In contrast, unsecured bonds are issued against the general credit of the borrower. These bonds are called deben- ture bonds. (b) Term bonds mature at a single specified future date. In contrast, serial bonds mature in in- stallments. (c) Registered bonds are issued in the name of the owner. In contrast, bearer (coupon) bonds are issued to bearer and are unregistered. Holders of bearer bonds must send in coupons to re- ceive interest payments. (d) Convertible bonds may be converted into common stock at the bondholders’ option. In con- trast, callable bonds are subject to call and retirement at a stated dollar amount prior to matur- ity at the option of the issuer. 4. (a) Face value is the amount of principal due at the maturity date. (Face value is also called par value.) (b) The contractual interest rate is the rate used to determine the amount of cash interest the borrower pays and the investor receives. This rate is also called the stated interest rate be- cause it is the rate stated on the bonds. (c) A bond indenture is a legal document that sets forth the terms of the bond issue. (d) A bond certificate is a legal document that indicates the name of the issuer, the face value of the bonds, and such other data as the contractual interest rate and maturity date of the bonds. 5. The two major obligations incurred by a company when bonds are issued are the interest payments due on a periodic basis and the principal which must be paid at maturity. 6. Less than. Investors are required to pay more than the face value; therefore, the market interest rate is less than the contractual rate.
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7. No, Elizabeth is not right. The market price on any bond is a function of three factors: (1) The dollar amounts to be received by the investor (interest and principal), (2) The length of time until the amounts are received (interest payment dates and maturity date), and (3) The market interest rate.
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