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Companies are mostlikelyto engage in offbalance sheet

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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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