32. non current (web, sch, cfa)
At the beginning of 20X6, Cougar Corporation enters a finance lease requiring five annual payments of $10,000 each beginning on the first day of the lease. Assuming the lease interest rate is 8%, the amount of interest expense recognized by Cougar in 20X6 is closest to: A. $2,650. B. $3,194. C. $3,450.
A At the inception of the lease, the present value of the lease payments is $43,121 (BGN mode: N = 5, I = 8, PMT = 10,000, FV = 0, solve for PV). After the first payment is made, the balance of the lease liability is $43,121 - 10,000 principal payment = $33,121. Interest expense for the first year is $33,121 x 8% = $2,650.
At the end of last year, Maui Corporation's assets and liabilities were as follows: Total assets $98,500 Accrued liabilities $5,000 Short-term debt $12,000 Bonds payable $39,000 Maui's debt-to-equity ratio is closest to: A. 1.2. B. 1.3. C. 1.4.
A Because A- L = E, shareholders' equity is 98,500 assets- 5,000 accrued liabilities 12,000 short-term debt — 39,000 bonds payable = $42,500. Thus, debt-to-equity is (12,000 short-term debt + 39,000 bonds payable) / 42,500 equity = 1.2. Only interest bearing liabilities are considered debt. Accrued liabilities are not interest bearing.
A firm issues a $10 million bond with a 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. The annual coupon payments will each be: A. $600,000. B. $676,290. C. $700,000.
A Coupon payment = (coupon rate x face value of bond) = 6% X $10,000,000 = $600,000.
A firm issues a $10 million bond with a 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. Total of all cash payments to the bondholders is: A. $12,400,000. B. $12,738,721. C. $12,800,000.
A Four coupon payments and the face value = ($600,000 x 4) + $10,000,000 = $12,400,000.
Using the effective interest rate method, the reported interest expense of a bond issued at a premium will: A. decrease over the term of the bond. B. increase over the term of the bond. C. remain unchanged over the term of the bond.
A Interest expense is based on the book value of the bond. As the premium is amortized, the book value of the bond decreases until it reaches face value.
According to U.S. GAAP, the coupon payment on a bond is: A. reported as an operating cash outflow. B. reported as a financing cash outflow. C. reported as part operating cash outflow and part financing cash outflow.
A The actual coupon payment on a bond is reported as operating cash outflow under U.S. GAAP.
A firm issues a $10 million bond with a 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. The bond can be classified as a: A. discount bond. B. par bond. C. premium bond.
A This bond is issued at a discount since the coupon rate < market rate.
Fairmont Golfissued fixed rate debt when interest rates were 6 percent. Rates have since risen to 7 percent. Using only the carrying amount (based on historical cost) reported on the balance sheet to analyze the company's financial position would most likely cause an analyst to: A. overestimate Fairmont's economic liabilities. B. underestimate Fairmont's economic liabilities. C. underestimate Fairmont's interest coverage ratio.
A is correct When interest rates rise, bonds decline in value. Thus, the carrying amount of the bonds being carried on the balance sheet is higher than the market value. The company could repurchase the bonds for less than the carrying amount, so the economic liabilities are overestimated. Because the bonds are issued at a fixed rate, there is no effect on interest coverage.
Cavalier Copper Mines has $840 million in total liabilities and $520 million in shareholders' equity. It discloses commitments are treated as debt, the debt-to-total-capital ratio is closest to: A. 0.58. B. 0.62. C. 0.64.
C is correct. The current debt-to-total-capital ratio is $840/($840+$520) = 0.62. To adjust for the lease commitments, an analyst should add $100 to both the numerator and denominator: $940/($940+$520) = 0.64
Assume a city issues a $5 million bond to build a new arena. The bond pays 8 percent semiannual interest and will mature in 10 years. Current interest rates are 9%. Interest expense in the second semiannual period is closest to: A) $106,550. B) $210,830. C) $80,000.
B Step 1: Compute the present value of the bond: Since the current interest rate is above the coupon rate the bond will be issued at a discount. FV = $5,000,000; N = 20; PMT = (0.04)(5 million) = $200,000; I/Y = 4.5; CPT PV = -$4,674,802 Step 2: Compute the interest expense at the end of the first period. = (0.045)(4,674,802) = $210,366 Step 3: Compute the interest expense at the end of the second period. = (new balance sheet liability)(current interest rate) = $4,674,802 + $10,366 = $4,685,168 new balance sheet liability (0.045)(4,685,168) = $210,833
Assuming all else equal, if the coupon rate offered on a bond is less than the corresponding market rate of interest, the bond will be issued at: A) a premium. B) a discount. C) par.
B If the coupon rate is less than the market rate, the bond must be sold at a discount so the effective rate on the bond equals the market rate.
For a given lease payment and term, which of the following is least accurate regarding the effects of the classification of the lease as a finance lease as compared to an operating lease? A) The lessee's asset turnover will be lower for a finance lease. B) The lessee's current ratio will be higher for a finance lease. C) The lessee's debt-to-equity ratio will be higher for a finance lease.
B The lessee's current ratio will be lower because the current portion of the finance lease increases current liabilities, hence reducing the current ratio.
Which of the following is least likely to be disclosed in the financial statements of a bond issuer? A) Collateral pledged as security in the event of default. B) The market rate of interest on the balance sheet date. C) The amount of debt that matures in each of the next five years.
B The market rate on the balance sheet date is not typically disclosed. The amount of principal scheduled to be repaid over the next five years and collateral pledged (if any) are generally included in the footnotes to the financial statements.
Which of the following statements for a bond issued with a coupon rate above the market rate of interest is least accurate? A) The bond will be shown on the balance sheet at the premium value. B) The value of the bond will be amortized toward zero over the life of the bond. C) The associated interest expense will be lower than that implied by the coupon rate.
B The value of the bond premium will be amortized toward zero over the life of the bond, not the value of the bond.
According to U.S. GAAP, which of the following would least likely require a lessee to capitalize a lease? A) The lease term is 75% or more of the estimated life of the leased asset. B) The lessee has an option to purchase the asset for its fair market value at the end of the lease. C) The present value of the minimum lease payments is 90% or more of the fair value of the leased asset.
B Under U.S. GAAP, a lease must be capitalized if it contains a bargain purchase option, not just a purchase option.
The asset or liability reported on the balance sheet for a defined benefit plan is equal to the plan's funded status under: A) Both IFRS and U.S. GAAP. B) U.S. GAAP, but not IFRS. C) Neither IFRS nor U.S. GAAP.
B Under U.S. GAAP, the asset presented for an overfunded plan or liability presented for an underfunded plan is the plan's funded status. Under IFRS, the asset or liability presented does not include unrecognized prior service costs or unrecognized actuarial gains and losses.
A firm issues a $5 million zero coupon bond with a maturity of four years when market rates are 8%. Assuming semiannual compounding periods, the total interest on this bond is: A) $1,346,549. B) $1,200,000. C) $1,600,000.
A The interest paid on the bond will be the difference between the future value of the bond of $5,000,000 and the proceeds of the bond when it was originally issued. First find the present value of the bond found by N = 8; FV = 5,000,000; I = 4; PMT = 0; CPT PV = ?3,653,451. This is the amount of money the bond generated when it was originally issued. Then take the difference between the $5,000,000 future price and the $3,653,451 from the proceeds = $1,346,549 which is the interest paid on the bond.
Over time, the reported amount of the annual interest expense on a long-term bond issued at a discount will: A) increase. B) remain constant. C) decrease.
A A portion of the discount must be amortized to the interest expense each year. The amortized amount is debited to interest expense and credited to debt. So debt goes up. The interest expense is debt times the effective interest rate. Thus, interest expense will increase over time.
Nomad Company issued $1,000,000 face value 2-year zero coupon bonds on December 31, 20X2 to yield 8% interest. Bond proceeds were $857,339. In 20X3 Nomad recorded interest expense of $68,587. In 20X4 Nomad recorded interest expense of $74,074 and paid out $1,000,000 to redeem the bonds. Based on these transactions only, Nomad鈥檚 Statement of Cash Flows would show cash flow from operations (CFO) of: A) zero in all years. B) -$68,587 in 20X3 and -$74,074 in 20X4. C) -$142,661 in 20X4.
A All of the cash flows for zero coupon bonds are included in cash flow from financing activities and none in cash flow from operations.
When bonds are issued at a premium: A) earnings of the firm increase over the life of the bond as the bond premium is amortized. B) coupon interest paid decreases each period as bond premium is amortized. C) earnings of the firm decrease over the life of the bond as the bond premium is amortized.
A As bond premium is amortized, interest expense will be successively lower each period, thus increasing earnings over the life of the bond.
A company redeems $10,000,000 of bonds that it issued at par value for 101% of par or $10,100,000. In its statement of cash flows, the company will report this transaction as a: A) 10,100,000 CFF outflow. B) $10,000,000 CFF outflow and $100,000 CFO outflow. C) $10,100,000 CFO outflow.
A Cash paid to redeem a bond is classified as a cash flow from financing activities.
If a lessee enters into a finance lease rather than an operating lease, it can expect to have a: A) higher debt-to-equity ratio. B) higher return on assets. C) lower debt-to-equity ratio.
A Leasing the asset with an operating lease avoids recognition of the debt on the lessee's balance sheet. Having fewer assets and liabilities on the balance sheet than would exist if the assets were purchased increases profitability ratios (e.g., return on assets) and decreases leverage ratios (e.g., debt-to-equity ratio). In the case of a finance lease, the assets are reported on the balance sheet and are depreciated.
A $1,000 bond is issued with an 8% semiannual coupon rate and 5 years to maturity when market interest rates are 10%. What is the initial liability? A) 923. B) 855. C) 1023.
A FV = 1000; PMT = 80/2; N = 5 × 2; I/Y = 10/2; solve for PV = 923.
Larry Purcell, an entry-level fixed income analyst at Knowlton & Smeades LLC, was discussing debt covenants with his supervisor, Andy Holzman. During the meeting Purcell made the following statements regarding bond covenants: Statement 1: If a firm violates any of its debt covenants, the company will immediately go into bankruptcy and the creditors of the firm will take over the liquidation of its assets. Statement 2: Debt covenants are important in evaluating a firm's credit risk and to better understand how the restrictions of the covenants can affect the firm's growth prospects and choice of accounting policies. With respect to these statements: A) only one is correct. B) both are incorrect. C) both are correct.
A Lenders and other creditors use debt covenants in their lending agreements to restrict the activities of the debtor that could adversely impact the creditors' position. If any bond covenant is violated, the firm is in technical default on its debt. The creditors can demand payment of the debt, however, the terms are generally renegotiated. As such, the company does not automatically enter into bankruptcy and have its assets liquidated by the creditors.
A firm is more solvent if it has: A) low leverage ratios and high coverage ratios. B) low leverage and coverage ratios. C) high leverage and coverage ratios.
A Low leverage ratios suggest the firm has relatively little debt compared to its equity and assets. High coverage ratios suggest the firm generates enough earnings to meet its interest payments.
An employer offers a defined benefit pension plan and a defined contribution pension plan. The employer's balance sheet is most likely to present an asset or liability related to: A) the defined benefit plan. B) both of these pension plans. C) the defined contribution plan.
A Only a defined benefit plan has a funded status that would appear on the balance sheet as an asset or liability. Employer payments into a defined contribution plan are recognized as expenses in the period incurred.
A firm enters an operating lease to occupy two floors of an office building. This transaction will most likely decrease the firm's: A) fixed charge coverage ratio but will not affect its interest coverage ratio. B) leverage ratios and fixed charge coverage ratio. C) interest coverage ratio but will not affect its leverage ratios.
A The fixed charge coverage ratio is (EBIT + operating lease payments) / (interest payments + lease payments). Assuming this ratio is greater than one, entering an operating lease will decrease the ratio. Leverage ratios and the interest coverage ratio are not affected by operating lease payments.
Under an operating lease (versus a finance lease) which of the following is higher for the lessee? A) Cash flow from financing. B) Cash flow from operations. C) Assets.
A The lessee's cash flows from financing will be higher for an operating lease because the payments made for an operating lease are operating cash outflows, not financing cash outflows. The payments made under a finance lease are split between interest paid and principal. The latter is charged to cash flow from financing.
Which of the following statements regarding zero-coupon bonds is most accurate? A) A company should initially record zero-coupon bonds at their discounted present value. B) The interest expense in each period is found by applying the discount rate to the book value of debt at the end of the period. C) Interest expense is a combination of operating and financing cash flows.
A The liability initially recorded for a zero-coupon bond is equal to the proceeds received, which is the present value of the principal repayment discounted at the company's normal borrowing rate. Interest expense is found by applying the discount rate to the book value of debt at the beginning of the period, and there is no cash outflow from operations for a zero coupon bond.
On the lessee's cash flow statement, the principal portion of a finance lease payment is a: A) financing cash flow. B) operating cash flow. C) investing cash flow.
A The principal portion of a finance lease payment is a financing cash outflow for the lessee. The interest portion is an operating cash outflow.
A company issued an annual-pay bond with a face value of $135,662, maturity of 4 years, and 7% coupon, while the market interest rates are 8%. What is the unamortized discount on the date when the bonds are issued? A) $4,493. B) $499. C) $1,748.
A The unamortized discount rate at the time bonds are issued will be $4,493. Face value of bonds = $135,662. Proceeds from bond sale = $131,168.70 [I/Y = 8.00%; N = 4; PMT = $9,496.34 ($135,662 × 0.07 ); FV = $135,662; CPT → PV]. Unamortized discount = $4,493 = ($135,662 ? $131,169).
For a finance lease, the amount recorded initially by the lessee as a liability will: A) equal the present value of the minimum lease payments at the beginning of the lease. B) be less than the total of the minimum lease payments. C) equal the total of the minimum lease payments.
A With a finance lease, both an asset and liability are reported on the lessee's balance sheet, with lease payments divided between interest and principal components. The future payments on principal and interest must be discounted to present value at the beginning of the lease.
If a lease is treated as a finance lease, as compared to being treated as an operating lease, the effect on the lessee's current ratio and the debt/equity ratio will be an: Current Ratio Debt/Equity Ratio A) Decrease Increase B) Increase Increase C) Increase Decrease
A With finance leases the lessee's assets, current liabilities, and long-term liabilities will be greater than if the lease was an operating lease. With the debt to equity ratio, the liability is in the numerator, which results in an increase in the ratio. With the current ratio, current liabilities are increased and are in the denominator which results in a decrease in the ratio.
A company issued a bond with a face value of $67,831, maturity of 4 years, and 7% annual-pay coupon, while the market interest rates are 8%. What is the unamortized discount when the bonds are issued? A) $2,246.65. B) $1,748.07. C) $498.58.
A Coupon payment = ($67,831)(0.07) = $4,748.17. Present value of bond: FV = $67,831, N = 4, I = 8, PMT = $4,748.17, CPT PV = $65,584.35. Discount = $67,831 - $65,584.35 = $2,246.65.
Oil Exploration LLC paid $45,000 in printing, legal fees, commissions, and other costs associated with its recent bond issue. It is most likely to record these costs on its financial statements as: A. an asset under US GAAP and reduction ofthe carrying value of the debt under IFRS. B. a liability under US GAAP and reduction of the carrying value ofthe debt under IFRS. C. a cash outflow from investing activities under both US GAAP and IFRS
A is correct. Under US GAAP, expenses incurred when issuing bonds are generally recorded as an asset and amortised to the related expense (legal, etc.) over the life of the bonds. Under IFRS, they are included in the measurement of the liability. The related cash flows are financing activities.
A lessor will record interest income if a lease is classified as: A. a capital lease. B. an operating lease. C. either a capital or an operating lease.
A is correct. A portion of the payments for capital leases, either direct financing or sales-type, is reported as interest income. With an operating lease, all revenue is recorded as rental revenue.
Under US GAAP, a lessor's reported revenues at lease inception will be highest if the lease is classified as: A. a sales-type lease. B. an operating lease. C. a direct financing lease.
A is correct. A sales-type lease treats the lease as a sale of the asset, and revenue is recorded at the time of sale equal to the present value of future lease payments. Under a direct financing lease, only interest income is reported as earned. Under an operating lease, revenue from rent is reported when collected.
Consolidated Enterprises issues €10 million face value, five-year bonds with a coupon rate of6.5 percent. At the time of issuance, the market interest rate is 6.0 percent. Using the effective interest rate method of amortisation, the carrying value after one year will be closest to: A. €10.17 million. B. €10.21 million. C. €10.28 million
A is correct. The coupon rate on the bonds is higher than the market rate, which indicates that the bonds will be issued at a premium. Taking the present value of each payment indicates an issue date value of €10,210,618. The interest expense is determined by multiplying the carrying amount at the beginning of the period (€10,210,618) by the market interest rate at the time of issue (6.0 percent) for an interest expense of €612,637. The value after one year will equal the beginning value less the amount of the premium amortised to date, which is the difference between the amount paid (€650,000) and the expense accrued (€612,637) or €37,363. €10,210,618 — €37,363 = €10,173,255 or €10.17 million.
Innovative Inventions, Inc. needs to raise €10 million If the company chooses to issue zero-coupon bonds, its debt-to-equity ratio will most likely. A. rise as the maturity date approaches. B. decline as the maturity date approaches. C. remain constant throughout the life ofthe bond.
A is correct. The value ofthe liability for zero-coupon bonds increases as the discount is amortised over time. Furthermore, the amortised interest will reduce earnings at an increasing rate over time as the value ofthe liability increases. Higher relative debt and lower relative equity (through retained earnings) will cause the debtto-equity ratio to increase as the zero-coupon bonds approach maturity
Which of the following statements regarding finance and operating leases is least accurate? A) During the life of an operating lease, the rent expense equals the lease payment. B) For financial reporting of finance and operating leases, no entry is required on the lessee's balance sheet at the inception of the lease. C) Asset turnover is higher for the lessee with an operating lease than a finance lease.
B If the lease is an operating lease there is no entry made on the balance sheet for the lessee. For finance leases, the leased asset and liability are recognized on the balance sheet by the amount equal to the present value of the minimum lease payments using as the discount rate the lower of the lessor's implicit rate or the lessee's incremental borrowing rate.
Under a finance lease (versus an operating lease) which of the lessee's financial ratios will be higher? A) Asset turnover. B) Debt/equity. C) Return on equity.
B The debt/equity ratio will be higher because the finance lease requires the creation of a long-term liability on the balance sheet.
Which of the following provisions would least likely be included in the bond covenants? The borrower must: A) maintain insurance on the collateral that secures the bond. B) maintain a debt-to-equity ratio of no less than 2:1. C) not increase dividends to common shareholders while the bonds are outstanding.
B A lender wants to prohibit the borrower from becoming more leveraged. This can be done by requiring a leverage ratio that is no more than a specified amount. Reducing leverage would be beneficial to the lender by lowering risk.
Which of the following statements that classify a lease as a finance lease under U.S. GAAP is least accurate? A) Title is transferred at the end of the lease period. B) The present value of the lease payments is at least 80% of the fair market value of the asset. C) A bargain purchase option exists.
B For a lease to be classified as a finance (capital) lease the present value of the lease payments must be at least 90% of the fair market value of the asset.
For a firm financed with common stock and long-term fixed-rate debt, an analyst should most appropriately adjust which of the following items for a change in market interest rates? A) Interest expense. B) Debt-to-equity ratio. C) Cash flow from financing.
B For the purpose of analysis, the value of debt should be adjusted for a change in interest rates. This will change the debt-to-equity ratio. Because changes in interest rates will change the market value of the debt, but not the coupon, interest expense will be unchanged. (However, if a firm has variable-rate debt, interest expense will change when interest rates change, but the market value of the variable-rate debt will not change significantly.)
The lessee has an incentive to classify a lease as an operating lease, rather than as a finance lease, because an operating lease: A) has no risk involved because the lessor assumes all risk. B) does not appear on the balance sheet. C) has payments that are less than a capital lease's payments.
B Having less assets and liabilities on the balance sheet than would exist if the asset were purchased increases profitability ratios (e.g., return on assets) and decreases leverage ratios (e.g., the debt to equity ratio).
A firm can recognize a gain or loss on derecognition of a bond the firm has issued: A) either before maturity or at maturity. B) before maturity, but not at maturity. C) at maturity, but not before maturity.
B If a firm redeems a bond before maturity for a price that is different from the carrying value of the bond liability, the firm will recognize the difference as a gain or a loss. At maturity, the carrying value of the bond liability is equal to the face value of the bond, therefore the firm does not experience a gain or loss by repaying the face value.
Compared to a finance lease, an operating lease is most likely to be favored when: A) management compensation is not based on returns on invested capital. B) the lessee has bond covenants relating to financial policies. C) at the end of the lease, the lessee may be better able to sell the asset than the lessor.
B If the lessee has bond covenants (e.g., debt-to-equity ratio) relating to its financial policies that it must follow, it is best to have an operating lease due to the fact that the operating lease will keep the asset off of the balance sheet resulting in less liabilities.
Interest expense is reported on the income statement as a function of: A) the coupon payment. B) the market rate. C) the unamortized bond discount.
B Interest expense is always equal to the book value of the bond at the beginning of the period multiplied by the market rate at issuance.
As compared to purchasing an asset, which of the following is least likely an incentive to structure a transaction as a finance lease? A) Risk of obsolescence is reduced because the asset is returned to the lessor. B) The lease enhances the balance sheet by the lease liability. C) The terms of the lease can be negotiated to better meet each party's needs.
B Operating leases enhance the balance sheet by excluding the lease liability. With a finance lease, an asset and a liability are reported on the balance sheet just like a purchase made with debt.
The Mader Corporation leases an asset for five years with lease payments of $10,000 per year. If Mader classifies the lease as a finance lease, which financial statements are affected at the end of the first year? A) Income statement and balance sheet only. B) Statement of cash flows, income statement, and balance sheet. C) Income statement only.
B The classification of a lease as a finance lease creates an asset, a debt obligation, financing cash flows (amortization of the loan), and operating cash flows (interest expense).
The difference between a defined benefit pension plan's assets and its defined benefit obligation is best described as the plan's: A) prior service cost. B) funded status. C) actuarial gain or loss.
B The funded status of a defined benefit plan is the difference between the plan's assets and the defined benefit obligation. If assets are greater than the obligation, the plan is said to be overfunded, and if assets are less than the obligation, the plan is said to be underfunded.
Which of the following is least likely disclosed in the financial statement footnotes of a lessee? A) A general description of the leasing arrangement. B) The lease interest rate. C) The lease payments to be paid in each of the next five years.
B The interest rate used by the lessee is not a required disclosure.
In analyzing disclosures related to the financing liabilities of a company, which of the following disclosures would be least helpful to the analyst? A) The interest expense for the period as provided on the income statement or in a footnote. B) The present value of the future bond payments discounted at the coupon rate of the bonds. C) Filings with the Securities and Exchange Commission (SEC) that disclose all outstanding securities and their features.
B When analyzing disclosures related to financing liabilities, analysts would review the balance sheet and find the present value of the promised future liability payments. These payments would then be discounted at the rate in effect at issuance (i.e., the yield to maturity), not the coupon rate of the bonds.
At the date of issuance the market interest rate was above the coupon rate. Bonds of this nature would sell for: A) par. B) discount. C) premium.
B When the contract rate on a bond is lower than the market rate, a bond will sell for a discount.
Which of the following statements about the impact of leases on the financial statements of the lessee is least accurate? A) Net income is lower in the early years of a finance lease than an operating lease. B) Cash flow from investing is higher for a finance lease than an operating lease. C) A finance lease results in higher liabilities compared to an operating lease.
B Cash flow from investing is not affected by a lease being either a finance or an operating lease. Finance leases reduce cash flow from operations by only the portion of the lease payment attributed to interest expense. Cash flow from financing is reduced by the rest of the finance lease payment which is the principal part of the payment.
A firm issues a $10 million bond with a 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. The initial book value of the bonds is: A. $9,400,000. B. $9,661,279. C. $10,000,000.
B The present value of a 4-year annuity of $600,000 plus a 4-year lump sum of $10 million, all valued at a discount rate of 7%, equals $9,661,279. Choice C can be eliminated because the bond was issued at a discount.
A firm issues a $10 million bond with a 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. For analytical purposes, what is the impact on the debt-to-equity ratio if the market rate of interest increases after the bond is issued? A. An increase. B. A decrease. C. No change.
B An increase in the market rate will decrease the price of a bond. For analytical purposes, adjusting the bond liability to its economic value will result in a lower debt-to-equity ratio (lower numerator and higher denominator).
A firm issues a $10 million bond with a 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. The total interest expense reported by the issuer over the life of the bond will be: A. $2,400,000. B. $2,738,721. C. $2,800,000.
B Coupon payments + discount interest = coupon payments + (face value- issue value) = $2,400,000 + ($10,000,000- $9,661,279) = $2,738,721.
A firm issues a $10 million bond with a 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. For the first period the interest expense is: A. $600,000. B. $676,290. C. $700,000.
B Market interest rate x book value = 7% x $9,661,279 = $676,290.
Compared to using a finance lease, a lessee that makes use of an operating lease wall most likely report higher: A. debt B. rent expense. C. cash flow from operating activity.
B is correct An operating lease is not recorded on the balance sheet (debt is lower), and lease payments are entirely categorised as rent (interest expense is lower.) Because the rent expense is an operating outflow but principal repayments are financing cash flows, the operating lease will result in lower cash flow from operating activity
Which of the following is most likely a lessee's disclosure about operating leases? A. Lease liabilities. B. Future obligations by maturity. C. Net carrying amounts of leased assets.
B is correct The lessee will disclose the future obligation by maturity of its operating leases. The future obligations by maturity, leased assets, and lease liabilities will all be shown for finance leases.
For a lessor, the leased asset appears on the balance sheet and continues to be depreciated when the lease is classified as: A. a sales-type lease. B. an operating lease. C. a financing lease
B is correct When a lease is classified as an operating lease, the underlying asset remains on the lessor's balance sheet. The lessor will record a depreciation expense that reduces the asset's value over time.
On 1 January 2010, Elegant Fragrances Company issues £1 ,000,000 face value, five-year bonds with annual interest payments of£55,000 to be paid each 31 December. The market interest rate is 6.0 percent. Using the effective interest rate method of amortisation, Elegant Fragrances is most likely to record: A. an interest expense of£55,000 on its 2010 income statement. B. a liability of£982,674 on the 31 December 2010 balance sheet. C. a £58,736 cash outflow from operating activity on the 2010 statement of cash flows.
B is correct. The bonds will be issued at a discount because the market interest rate is higher than the stated rate. Discounting the future payments to their present value indicates that at the time of issue, the company wall record £978,938 as both a liability and a cash inflow from financing activities. Interest expense in 2010 is £58,736 (£978,938 times 6.0 percent). During the year, the company will pay cash of£55,000 related to the interest payment, but interest expense on the income statement will also reflect £3,736 related to amortisation ofthe initial discount (£58,736 interest expense less the £55,000 interest payment). Thus, the value ofthe liability at 31 December 2010 will reflect the initial value (£978,938) plus the amortised discount (£3,736), for a total of £982,674. The cash outflow of £55,000 may be presented as either an operating or financing activity under IFRS
A company issues €1 million of bonds at face value. When the bonds are issued, the company will record a: A. cash inflow from investing activities. B. cash inflow from financing activities. C. cash inflow from operating activities.
B is correct. The company receives €1 million in cash from investors at the time the bonds are issued, which is recorded as a financing activity.
Penben Corporation has a defined benefit pension plan. At 31 December, its pension obligation is €10 million closest to which of the following? A. €10 million is shown as a liability, and €9 million appears as an asset B. €1 million is shown as a net pension obligation. C. Pension assets and obligations are not required to be shown on the balance sheet but only disclosed in footnotes.
B is correct. The company will report a net pension obligation of €1 million equal to the pension obligation (€10 million) less the plan assets (€9 million).
At the time of]issue of 4.50% coupon bonds, the effective interest rate was 5.00%. The bonds were most likely issued at: A. par. B. a discount C. a premium
B is correct. The effective interest rate is greater than the coupon rate and the bonds will be issued at a discount
When the market rate is greater than the coupon rate, the bond is called a: A) par bond. B) premium bond. C) discount bond.
C When the market rate is greater than the coupon rate, the bond will sell at a discount as investors will only buy the bond at a price which is less than fair value due to the coupon being lower than the market rate.
Which of the following statements regarding the issuance of a discount bond is most accurate? A) The cash from investing (CFI) is increased by the amount of the proceeds. B) The cash from operations (CFO) is understated. C) The cash from financing (CFF) is increased by the amount of the proceeds.
C The cash from financing (CFF) is increased by the amount of the proceeds. The cash from operations (CFO) is overstated because it will not include the amortization of the discount, which increases interest expense. There is no effect on CFI.
On December 31, 20X3 Okay Company issued 10,000 $1000 face value 10-year, 9% bonds to yield 7%. The bonds pay interest semi-annually. On its financial statements (prepared under U.S. GAAP) for the year ended December 31, 20X4, the effect of this bond on Okay's cash flow from operations is: A) -$700,000. B) -$755,735. C) -$900,000.
C The coupon payment is a cash outflow from operations. ($10,000,000 * 0.09) = $900,000.
A lessee most likely has an incentive to structure a lease as an operating lease rather than a finance lease when it: A) does not have debt covenants. B) is very profitable. C) has a high debt-to-equity ratio.
C A firm with a high debt-to-equity ratio is more likely to use an operating lease instead of a capital lease. Use of an operating lease avoids the recognition of debt on the lessee's balance sheet and will not increase the debt-to-equity ratio.
Penguin Company is planning to lease a $5 million machine to produce goods for eventual sale. Penguin is able to structure the lease so as to classify it as either an operating or a finance lease. Advantages to Penguin of classifying this lease as an operating lease are least likely to include that: A) depreciation is not recorded. B) the lease is not reported as debt on Penguin's balance sheet, so leverage ratios are not increased. C) no disclosures of payments due under the lease are required.
C Cash payments due under an operating lease must be disclosed in the notes to the financial statements for each of the following five years and in aggregate. Operating leases are simpler to account for and the often adverse ratio implications of offsetting increases in assets and liabilities are avoided.
Which of the following is least likely one of the criteria under U.S. GAAP for classifying a lease as a finance lease? The: A) lease contains a bargain purchase option. B) term of the lease is 75% or more of the estimated economic life of the leased property. C) lessor retains ownership of the property at the end of the lease term.
C If the lease transfers ownership of the property to the lessee at the end of the lease term, the lessee will classify the lease as a finance lease.
Which of the following statements regarding the effect of a finance lease on the lessee's statement of cash flows is least accurate? A) The change in the finance lease liability on the balance sheet is a cash flow from financing. B) The interest expense portion of the lease payments reduces cash flow from operations. C) The rental expense serves to reduce the cash flow for financing because it is an investment expense.
C In finance leases, there is only interest expense and principal repayment. Rental expense is only charged when the lease is an operating lease.
Which of the following statements regarding a direct financing lease is least accurate? A) The principal portion of the lease payment is a cash inflow from investing on the lessor's cash flow statement. B) The lessor recognizes no gross profit at the inception of the lease. C) Interest revenue on the lessor's income statement equals the implicit interest rate times the lease payment.
C Interest revenues are calculated by multiplying the implicit interest rate by net receivables at the beginning of the period.
An analyst compares two companies that are identical except that Company X uses finance leases and Company Y uses operating leases. The analyst would expect Company X's debt-to-equity ratio, relative to Company Y's, to be: A) lower. B) the same. C) higher.
C Lease capitalization adds both current and noncurrent liabilities to debt, resulting in a corresponding increase in the debt-to-equity and other leverage ratios. Thus, Company X's (Debt + Lease)/Equity is greater than Company Y's Debt/Equity.
Other things equal, and ignoring issuance costs, a firm that raises cash by issuing a new bond is most likely to: A) increase its leverage ratios and increase its coverage ratios. B) decrease its leverage ratios and increase its coverage ratios. C) increase its leverage ratios and decrease its coverage ratios.
C Leverage ratios will increase because debt increases while equity remains unchanged, and (assuming equity is positive) debt increases proportionally by more than assets. Coverage ratios decrease because interest payments increase while EBIT is unchanged.
Which of the following statements about leases is least accurate? A) In the first years of a finance lease, the lessee's debt to equity ratio is greater than it would have been if the firm had used an operating lease. B) All else equal, when a lease is capitalized the lessee's income will rise over the term of the lease. C) In the first years of a finance lease, the lessee's current ratio is greater than it would have been had the firm used an operating lease.
C From the lessee's perspective, if a lease is considered to be a finance lease instead of an operating lease, then the lessee's current liabilities will be greater until the lease has expired. This will result in a lower current ratio (larger denominator). In the early years, the capitalized lease expense (interest plus depreciation) is greater than in the later years because interest expense decreases over time. Less expenses = more income. In the first years of a finance lease the lessee's debt to equity ratio will be greater than if the firm had used an operating lease because in the case of the finance lease, the numerator is comprised of (debt + lease), while the numerator in the case of the operating lease is (debt) only. In addition, the greater capitalized lease expense flows through to decrease shareholder's equity (the denominator).
A company issued an annual-pay bond with the following characteristics: Face value $67,831 Maturity 4 years Coupon 7% Market interest rates 8% What is the unamortized discount on the date when the bonds are issued? A) $15,729. B) $1,748. C) $2,249.
C The unamortized discount at the time bonds are issued will be $2,249. Face value of bonds = $67,831 Proceeds from bond sale = $65,582 [I/Y = 8.00%; N = 4; PMT = $4,748.17 ($67,831 × 0.07); FV = $67,831; CPT → PV] Unamortized discount = $2,249 ($67,831 ? $65,582)
As compared to purchasing an asset, which of the following is least likely an incentive to structure a transaction as a finance lease? A. At the end of the lease, the asset is returned to the lessor. B. The terms of the lease terms can be negotiated to better meet each party's needs. C. The lease enhances the balance sheet by the lease liability.
C Operating leases enhance the balance sheet by excluding any lease liability. With a finance lease, an asset and a liability are reported on the balance sheet as with purchase made with debt.
Which of the following is least likely to be disclosed in the financial statements of a bond issuer? A. The amount of debt that matures in each of the next five years. B. Collateral pledged as security in the event of default. C. The market rate of interest on the balance sheet date.
C The market rate on the balance sheet date is not typically disclosed. The amount of debt principal scheduled to be repaid over the next five years and collateral pledged (if any) are generally included in the footnotes to the financial statements.
A firm issues a $10 million bond with a 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. If the market rate changes to 8% and the bonds are carried at amortized cost, the book value of the bonds at the end of the first year will be: A. $9,484,581. B. $9,661,279. C. $9,737,568.
C The new book value = beginning book value + interest expense- coupon payment = $9,661,279 + $676,290 — $600,000 = $9,737,569. The interest expense was calculated in question 5. Alternatively, changing N from 4 to 3 and calculating the PV will yield the same result. The change in market rates will not affect amortized costs.
The management of Bank EZ repurchases its own bonds in the open market. They pay €6.5 million for bonds with a face value of€10.0 million and a carrying value of€9.8 million. The bank will most likely report: A. other comprehensive income of €3.3 million. B. other comprehensive income of €3.5 million. C. a gain of€3.3 million on the income statement.
C is correct A gain of €3.3 million (carrying amount less amount paid) will be reported on the income statement.
Debt covenants are least likely to place restrictions on the issuer's ability to: A. pay dividends. B. issue additional debt C. issue additional equity.
C is correct Covenants protect debtholders from excessive risk taking, typically by limiting the issuer's ability to use cash or by limiting the overall levels of debt relative to income and equity. Issuing additional equity would increase the company's ability to meet its obligations, so debtholders would not restrict that ability.
