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Unformatted text preview: would make Southwest appear to be a less risky investment option. Since the return a company must pay
on investment capital is positively associated with the risks of the company, anything that would make
Southwest appear to be less risky should decrease its cost of capital. The real question, however, is
whether potential investors, in evaluating investment alternatives, focus solely on the debt reported on the
balance sheet or, instead, focus on the company's obligations reported in the footnotes to the financial
statements. The footnotes would usually disclose any major obligations under operating leases. ID11–4
a. The current portion of Long Term Debt ($221 million) appeared in the Current Liabilities section of the
balance sheet; the rest of the Long Term Debt, totaling $8,120 million, appeared in the longterm liabilities
section of Johnson & Johnson’s balance sheet. b. A zero coupon debenture is a debt instrument that has a stated rate of interest of 0%. The debenture
contract only requires the repayment of the face amount at maturity. However, because no company
borrows at zero percent, the debentures are sold at a discount depending on the effective rate of interest.
The zero coupon debenture that are due in 2020 carry an effective interest rate of 3.00, indicating that
Johnson & Johnson did not receive the face value of the debentures at funding but will have to repay the
face value at maturity (meaning that the company effectively is paying a 3% interest rate to borrow the
money). c. A bond contract with a stated rate of interest equal to the effective rate of interest will be sold at par (no
discount or premium). The 2033, 2023, 2017, 2038 and 2018 debentures carry effective rates equal to
their stated rates, therefore selling at par. d. The 6.95% notes due in 2029 were issued with an effective rate of interest of 7.14%, which is in excess of
the stated rate of 6.95%. Therefore, the notes were sold at a discount, meaning that the face amount...
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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