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greater than the balance sheet amount of $293 million. ID11–5
a. For the market value of the liability to increase so dramatically, market interest rates would have had to fall
substantially. b. Loss on long term debt 1,400
Long term debt 1,400 c. Loss on retirement of debt 1,400
Long term debt 8,300
Cash 9,700 d. a. b. Carrying the debt at fair market value would require the company to book the $1.4 billion loss, even if the
debt were not retired at that market price. On the other hand, carrying the debt at book value using the
effective interest rate method would show the $1.4 billion loss only if the debt were retired at current
market prices. If the debt were not retired, the loss would not be recorded.
A large amount of debt forces a company's management to place greater emphasis on generating cash so
that it has sufficient cash to make the required interest and principal payments. Thus, a company may
alter its operating, investing, and financing decisions to allow it to generate the cash it needs when it
The massive borrowing activity during the 1980s would have manifested itself as increased liabilities on the
companies' balance sheets. By analyzing different companies' current ratios and debt/equity ratios, which
are measures of a company's solvency, potential investors may have been able to identify those
companies that were taking on an excessive amount of debt. However, even this type of analysis may not
have been sufficient to identify overly risky companies. Companies will often engage in offbalance sheet
financing, such as structuring leasing arrangements as an operating lease. Companies are most likely to
engage in offbalance sheet financing when they are close to violating existing debt covenants that specify
a maximum debt/equity ratio or when the company already has a large amount of debt. Since, by
definition, offbalance sheet financing does not show up on the balance sheet as a liability, it will not be
reflected in either the current ratio or the debt/equity ratio.
An alternative analysis strategy investors could have used was to examine the statement of c...
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This homework help was uploaded on 03/03/2014 for the course ACCT 5053 taught by Professor Staff during the Fall '08 term at Oklahoma State.
- Fall '08