Chapter 9
What information does the times interest earned ratio provide to investors or creditors?
It provides the creditor with an indication of the ability of the debtor to pay the interest on its debts.
debt financing
borrowing money from creditors (liabilities)
Smith Company enters into a lease agreement with Rent-All Corp. The present value of the lease payments is equal to $25,000. Smith records:
debit lease asset $25,000 credit lease payable $25,000
The two types of financing are:
debt financing and equity financing
When bonds are issued at a premium, the carrying value of the debt ___________ over time
decreases
For a bond issued at a discount, the stated interest rate will be ___________ than its yield or return earned by bond investors.
lower
Identify the characteristics of an annuity
a series of amounts that are equal equal time periods between payment dates
In a private placement of bonds, bonds may be sold to
a single large investor
________ bonds are retired when the bondholder exchanges them for the issuing company's stock.
convertible
two ratios commonly used to assess a company's financial risk
debt to equity ratio times interest earned ratio
financing with ___________ requires borrowing, whereas financing with __________ requires issuing shares of stock.
debt; equity
Munchen Company sold bonds at a premium. Over the life of the bonds, the carrying value of the bonds will
decrease
A bond that sells for less than its face amount is sold at a(n)
discount
Merkel Corporation issues $200,000 face amount bonds with a stated interest rate of 6%. If the market interest rate is 7%, the bonds will issue at
discount
Bonds may issue at:
face amount, a discount, a premium
The debt to equity and the times interest earned ratios provide investors and creditors with a measure of ______ risk
financial
When market interest rates go up, the market value of bonds
goes down
The times interest earned ratio provides an indication of
how many times greater earnings are than interest expense
what are possible benefits of leasing an asset rather than purchasing an asset?
improvement in cash flows lower periodic payments on the asset protection against the declining asset value
Quattro Lending Company is considering lending a large sum to Eleance Inc. During its decision process, Quattro should especially consider Eleance's existing:
long-term liabilities
A common reason for redeeming a bond prior to its maturity date is that
market interest rates decreased.
An investment fund into which an organization makes payments each year over the life of its outstanding debt is referred to as a(n) _____________ fund
sinking
The ______________ rate of interest is used to compute the cash interest paid to bondholders.
stated
Bonds that require payment of the full principle amount of the bond at the end of the loan term are referred to as
term bonds
A bond that sells for more than its face amount is sold at a(n)
premium
Dorothea Inc. is selling all of its bonds to a large pension fund. This an example of a(n) _________ placement
private
On December 31, Katie Corp. records a journal entry related to an installment note that includes a debit to interest expense for $4,000, and a debit to notes payable for $9,000. Katie's journal entry should also include a credit to cash for:
$13,000 reason: 9,000 + 4,000= 13,000
serial bonds
bonds that mature in installments
ABC Company is in the process of issuing bonds. The bonds have a stated interest rate of 6%, which is 2% above the current market rate. What effect will the two interest rates have on the bond issue price?
The issue price will be above the bond's face value. reason: The 6% interest rate makes the bond more attractive and investors are willing to pay more.
When is it more economical for a company to borrow funds by issuing bonds?
When the interest savings exceed the additional bond issuance costs.
Periodic payments on installment notes typically include
a portion that reduces the outstanding loan balance and a portion that reflects interest
A corporation that wishes to borrow from the general public rather than a bank will issue
bonds
The Discount on Bonds Payable account is classified as a(n)
contra-liability
A company that earns a return in excess of the cost of borrowing the funds is providing its shareholder with a greater return than what would have been earned with:
equity
In order to expand its business, Mueller Inc. is selling $10 million in common stock. Mueller is utilizing this type of financing:
equity
The rate of interest printed on the face of a bond is referred to as the _______ interest rate
face
Bonds and leases are normally classified as ______ liabilities
long-term
The ____________ rate of interest is an implied rate based on the price investors pay to purchase a bond
market
Munster Inc. issues $20 million in bonds and pledges its land holdings as collateral. Munster's bonds are:
secured
Bonds that mature on one specific date are called ____________ bonds, whereas bonds that mature in installments are referred to as _________ bonds
term; serial
The ratio that provides an indication to creditors of how much greater net income is than interest expense is called the
times interest earned ratio
most bonds issued today are
unsecured
Which of the following are the most common types of bonds?
unsecured
Margot Inc. issues $10 million in bonds, of which $2 million are due each year for the next 5 years. Margot Inc.'s bonds are commonly referred to as a
serial bonds
The ___________ rate of interest on a bond is the interest rate printed on the bond, whereas the ___________ rate of interest is the current rate of interest being paid on investments with similar characteristics.
stated; market
_______________ enables a company to earn a higher return using debt than without debt
leverage
The true interest rate used by investors to value a bond issue is referred to as the:
market interest rate
Which of the following statements is correct? a. Bonds may be retired at maturity or retired early. b. Bonds can be retired only at maturity. c. Bonds for which the effective interest rate rises must be retired early.
a. Bonds may be retired at maturity or retired early.
convertible bonds
bonds that can be exchanged for shares of stock in the issuing company
Match the bond features with the party/parties for whom they are most beneficial. callable convertible Primarily beneficial for lender (bond issuer) Beneficial for both, the borrower (bond issuer) and lender (bond investor)
callable- primarily beneficial for lender (bond issuer) convertible- beneficial for both, the borrower (bond issuer) and lender (bond investor)
Werner issues bonds at a discount. The related Discount account should be classified as a(n) __________ ____________
contra liability
Western Company enters into a lease agreement with ABC Rents. The present value of the lease payments is equal to $50,000. Western records:
debit lease asset $50,000; credit lease payable $50,000
Walker Inc. signs a $24,000 installment note, which requires equal monthly payments of $1,100 over the next two years. The journal entry to recognize the note includes a:
debit to Cash for $24,000 credit to Notes Payable for $24,000
Market rates of bonds vary depending on the ____________ risk of the company issuing the bonds.
default
True or false: The full balance of a 10 year installment note payable that requires annual payments is reported as long-term debt.
false
A bond will be issued at a discount when the market rate of interest is
greater than the stated rate
when a corporation repurchases its bonds from the bondholders, the corporation ________ the bonds
retired
____________ bonds are supported by a specific asset the issuer pledges as collateral.
secured
Which of the following are common characteristics or provisions of bonds?
secured or unsecured term or serial convertible callable
The ________________ rate of interest is used to pay periodic interest on the bonds, whereas the market rate of interest is used to calculate interest expense.
stated
Callable bonds can be redeemed at the choice of
the bond issuer
Bondholders are willing to pay a premium to acquire a bond because
the bond's stated interest rate is higher than the market interest rate reason: a bond sells at a premium if the stated interest rate is higher than the market making it an attractive bond. If the bond's stated interest rate is lower than market, then the bond would not be attractive and sell at a discount. (the interest paid on the bond is not as high as what the market expects).
A corporation will issue bonds when
the interest on the bond plus the bond issue cost is less than the interest payments for a bank loan.
callable bonds
the issuing company can pay off the bonds at any time
A company's capital structure refers to
the mixture of debt and equity used to finance the company
Convertible bonds may be beneficial to bond investors because:
the value of the common stock shares received in the conversion may exceed the amount of the bond
Which of the following statements is correct? a. Bonds always sell for their face amount. b. Bonds sell for their face amount if they are issued near the original interest date. c. Bonds may sell below, above, or at their face amount.
c. Bonds may sell below, above, or at their face amount.
Merkel Corporation issues $200,000 face amount bonds with a stated interest rate of 6%. If the market interest rate is 6%, the bonds will issue at
face amount
On the maturity date, the carrying value of bonds issued at a premium will be equal to the
face amount
The carrying value at maturity is equal to the face amount of bonds issued at:
face amount, discount, and premium
True or false: The market interest rate for corporate bonds is the same for each company and is set by the Federal Reserve Board.
false, because market interest rates for bonds vary among companies based on their default risk.
Bonds will be issued a premium if the stated interest rate is
greater than the market interest rate
In order to assess a company's financial risk, investors and creditors frequently consider and analyze the company's:
long-term debt
Regardless of whether bonds are issued at face amount, a discount, or a premium, their carrying value is equal to face amount at the ___________ date
maturity
Mann Inc. issues $100,000 bonds at face amount. The bonds pay interest of 6%. Berkely Inc., a company with comparable risk, issues $100,000 bonds, paying 5% interest for $98,000 Which of the following is true?
Both bonds yield a return of 6% to investors.
Identify the correct statement(s) relating to common bond features.
Call features are more common than conversion features Bonds may be issued with both a call and a conversion feature
A high times interest earned ratio indicates the company:
can meet its interest obligations as they become due
term bonds
bond issues that mature on a single date
On January 1, year 1, Ziegler issued 5-year bonds with a stated rate of 8% and a face amount of $100,000. The bonds pay interest semiannually. The market rate of interest was 10%. Calculate the issue price of the bonds. Round your answer to the nearest dollar.
$92,278 reason: (7.72173 x $8,000 x 0.5) + (0.61391 x $100,000) = $92,278
What is typically shown in an amortization schedule related to an installment notes payable?
-The carrying value of the note at the beginning of the period -The carrying value of the note at the end of the period -The cash paid each payment period -The decrease in the carrying value of the note -Interest expense based on the beginning period carrying value and the effective rate of the loan
Wichtel Company issues $100,000 face amount, 10% semiannual bonds that are due in 7 years. The market interest rate is 8%. To calculate the issue price of the bonds, Wichtel should use an interest rate of ______% and _____ # of interest periods
4; 14 reason: 8%/2 = 4%; 7 years x 2 (semiannual) = 14
Cabot Inc. has 6%, $100,000 face amount bonds outstanding. The bonds were issued at a premium. At end of the current fiscal period, the balance of premium on bonds payable is $1,200.The balance sheet presentation of Cabot's bonds should include:
Bonds payable of $100,000 Plus premium on bonds payable of $1,200
Margot Inc. issues bonds with a stated rate of 5%; the company's market interest rate is 6%. The bonds will issue at:
a discount
Smith Company enters into a lease agreement with Rent-All Corp. At the beginning of the lease period, Smith Company records:
a lease asset a lease payable
A bond with an issue price of $10,100 and a face value of $10,000 was issued at
a premium
On December 31, Leann Corp. paid $5,120 on an installment note that requires annual payments. The outstanding loan balance on January 1 was $50,000; the effective interest rate is 8%. The journal entry to recognize the payment should include debits to
notes payable for $1,120 interest expense for $4,000.
what are the 3 primary sources of long-term debt financing?
notes payable, leases, and bonds
Tyler wants to calculate the issue price of bonds. He already knows the face amount and interest payment amount. He also needs to know the
number of periods to maturity
equity financing
obtaining investment from stockholders (stockholders' equity)
The market value of bonds move in the ________ direction of interest rates
opposite
Slater Company issues $1 million face amount bonds for $1.1 million. On the date of maturity, the carrying value of the bonds (assuming that interest has already been accrued) will be equal to
$1 million
XYZ Company has a 10 year installment note requiring $5,000 to be paid within the current year and $45,000 to be paid over the remaining 9 years. How is this installment note reported in the balance sheet of XYZ Company?
$5,000 current note payable; $45,000 long-term note payable
Emily uses a financial calculator to calculate the issue price of $100,000 face amount bonds. The bonds pay 6% interest semi-annually over a five-year period. The market interest rate is 6%. Select the correct input:
FV= 100,000 N= 10 I= 3
Which of the following are correct regarding bonds?
They obligate the issuing company to repay the bonds at a specific date They obligate the issuing company to pay a specific amount.
During the current year, Katie Corp. pays $5,120 on an installment note. The outstanding loan balance at the beginning of the year was $50,000; the effective interest rate is 8%. Which of the statements regarding the installment note balance at the end of the current year is correct? a. The balance is $48,880. b. The balance is $50,000. c. The balance is $44,880.
a. The balance is $48,880 reason: $50,000 - (5,120 - 4,000 interest)
A series of equal amounts paid or received over equal time periods is called a(n)
annuity
secured bonds
bonds are backed by collateral
Debt is considered a lower cost method of financing than equity because
interest on debt is tax deductible
A contract in which an owner provides a user the right to use an asset in return for periodic cash payments over a period of time is called a(n):
lease
a _____________ is a contractual arrangement in which an owner provides a user the right to use an asset for a specified period of time
lease
The debt to equity ratio is calculated as
Total Liabilities divided by Total Stockholders' Equity
At the beginning of the year, Petra owes $10,000 on an installment notes payable, which has an interest rate of 6%. At the end of the year, Petra makes a payment of $2,000. After the payment, the carrying value of the installment notes payable will be:
$8,600 reason: $10,000 - $(2,000 - (10,000 x .06) = $8,600
On January 1, year 1, Klondike issued 10-year bonds with a stated rate of 10% and a face amount of $100,000. The bonds pay interest annually. The market rate of interest was 12%. Calculate the issue price of the bonds. Round your answer to the nearest dollar.
$88,699 reason: (5.65022 x $10,000) + (0.32197 x $100,000) = $88,699
The higher the debt to equity ratio is for a company, the ______ the risk of bankruptcy is for that company.
higher
Loans requiring periodic payments of interest and principle are referred to as __________ notes
installment
Improved cash flows is a common advantage of acquiring equipment through:
leasing
In the U.S., the most popular method for financing corporate long-term assets is:
leasing
________________ has grown into the most popular method of external financing of corporate assets in America
leasing
A bond will be issued at a premium when the market rate of interest is __________ the stated rate
less than
A bond will be issued at a premium when the market rate of interest is ____________ the stated rate
less than
A company borrows funds for a project. If the interest rate charged for the borrowed funds is less than the rate of return on the project, this is referred to as financial ____________
leverage
Omar Inc. has 6%, $200,000 face amount bonds outstanding. The bonds were issued at a discount. At the end of the current fiscal period, unamortized bond discount is $4,500. The total bond-related liability reported on Omar's balance sheet should be:
$195,500 reason: 200,000- 4,500
On January 2, 2018, Meister Company issues $200,000 of 6% bonds. Interest of $6,000 is payable semiannually on June 30 and December 31. The bonds mature in 5 years. The bonds were issued at face amount. On the date of issue, Meister should recognize a liability of
$200,000
Omar Inc. has 6%, $200,000 face amount bonds outstanding. The bonds were issued at a premium. At the end of the current fiscal period, the balance of premium on bonds payable is $4,500. The liability reported on Omar's balance sheet should be:
$204,500
Smith uses a financial calculator to calculate the issue price of $800,000 face amount bonds. The bonds pay 8% interest semi-annually over a five-year period. The market interest rate is 8%. Select the correct input:
FV= $800,000 (face is paid in the future) PMT= 32,000 (Interest payment each 6 months) N= 10 (number of semi-annual interest payments) I= 4 (the market rate for 6 months)
Corporate bonds most often pay interest
SemiannuallyThe true interest rate used by investors to value a bond issue is referred to as the:
Which of the following information is necessary to calculate the issue price of bonds? a. current prime interest rate b. interest payment each period c. face amount of bonds d. fair value of comparable bonds e. number of periods to maturity
b. interest payment each period c. face amount of bonds e. number of periods to maturity
If bonds are retired before the maturity date, this is considered a(n)
early extinguishment of debt
Debt can be an advantage for stockholders if it
earns a return on borrowed funds that exceeds the cost of borrowing
Common terms used for the market interest rate are:
effective interest rate yield rate
Neumann Corporation is planning to issues bonds with a face amount of $2 million. If Neumann's accountant, Betty, wants to calculate the expected issue she should calculate the ___________ of the related future cash payments using the ________ interest rate
present value; market
Convertible bonds may be beneficial to lenders (bond issuer) because they tend to:
require a lower interest rate than bonds issued without the conversion feature
At the beginning of a lease period, the lessee records
a lease asset and lease payable for the present value of the lease payments.
Cabot Inc. has 6%, $100,000 face amount bonds outstanding. The bonds were issued at a discount. At end of the current fiscal period, unamortized bond discount is $1,200.The balance sheet presentation of Cabot's bonds should include:
bonds payable $100,000 less discount on bonds payable of $1,200
Which of the following is true regarding a debenture bond?
It is secured by the faith and credit standing of the issuer.
An early extinguishment of debt occurs if bonds or any type of debt are retired prior to the _________ date
maturity
Hainzel Company issues $200,000 face amount, 6% semiannual bonds that are due in 7 years. If the market interest rate is 5%, the bonds will achieve an issue price of: (round to the nearest whole dollar)
$211,692 reason: ($200,000 x 0.70773)+ ($6,000 x 11.69091)
The journal entry to recognize the signing of an installment notes payable includes:
Debit cash Credit notes payable
Which of the following are typically shown in an amortization schedule related to an installment notes payable requiring period payment of interest and principal?
The decrease in the carrying value of the note The cash paid each payment period The carrying value of the note at the end of the period Interest expense based on the beginning period carrying value and the effective rate of the loan
Glueck Company issues bonds with a stated rate of 5% and a market rate of 4%. Glueck's bonds will issue at
a premium
