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Unformatted text preview: pany would not have recognized any loss if it had not repurchased its debt. Unless there is evidence to the contrary, such as a company repurchasing its debt, accountants assume that when a company issues debt, the debt will remain outstanding until it matures. This implies that changes in the market value of the debt are irrelevant to the financial position of the company as reported in its financial statements. ID11–2 a. The stated interest rate affects only the magnitude of periodic interest payments. What is important to investors is the rate of return on their investments. Thus, if an investor is not in need of periodic cash payments, a non­interest­bearing obligation that provides a competitive rate of return is an attractive investment option. b. The rate that discounts $200 million due in eight years to a present value of $66.48 million is 14.75%. c. If bonds have a stated rate, the company has to have sufficient cash flow to make the periodic interest payments. Thus, if a company does not expect to have sufficient cash flows to support periodic interest payments, it is to the company's advantage to issue bonds with a stated interest rate of zero. ID11–2 Concluded d. To simplify the calculations, the effective interest rate of 14.75% [see part (b)] is rounded to 15%. 5% stated rate Present value of $200 million paid in 8 years $200 million .32690 (from Table 4 in Appendix A) Present value of periodic interest payments ($200 million 5%) 4.48732 (from Table 5 in Appendix A) Issue price $ 65,380,000 44,873,200 $ 110,253,200 18% stated rate Present value of $200 million paid in 8 years $200 million .32690 (from Table 4 in Appendix A) Present value of periodic interest payments ($200 million 18%) 4.48732 (from Table 5 in Appendix A) Issue price $ 65,380,000 161,543,520 $ 226,923,520 ID11–3 a. The effective interest rate is the interest rate that equates the undiscounted future cash flows with the present value of the future cash flows. For both alternatives, the undiscounted cash flows are only the fifteen annual payments of $6 million each, and the present value of both alternatives is the $45,636,480 price of the jet plane. The equation to equate the undisc...
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