Chapter 9 ACG 2021

Why would a company choose to borrow money rather than issue additional stock in the company?

Interest expense incurred when borrowing money is tax-deductible, whereas dividends paid to stockholders are not tax-deductible

Equity Financing

Obtaining additional investment from Stockholders Stockholders Equity Right side of the accounting equation

early extinguishment of debt

Regardless of whether bonds are issued at face amount, a discount, or a premium, their carrying value at maturity will equal their face amount.

Market Interest Rate

The market interest rate represents the true interest rate used by investors to value RC's bond issue. The market rate can be equal to, less than, or greater than the stated 7% interest rate paid to investors. market rate is determined for each bond issue by the forces of supply and demand.

Capital Structure

The mixture of liabilities and stockholders' equity for a business

Operating Leases

They are like rentals The lessor owns the asset, and the lessee simply uses the asset temporarily. Over the lease term, the lessee records rent expense and the lessor records rent revenue.

Secured Bonds

They are supported by specific assets the issuer has pledged as collateral.

times interest earned ratio.

This ratio compares interest expense with income available to pay those charges.

Convertible Bonds

a call feature is more common than a conversion feature benefit both the borrower and the lender allow the lender (the investor) to convert each bond into a specified number of shares of common stock. Convertible bonds sell at a higher price and require a lower interest rate than bonds without a conversion feature.

Bond Indenture

a contract between a firm issuing bonds to borrow money (the issuer) and the corporations or individuals who purchase the bonds as investments (the investors) the bond indenture is held by a trustee, usually a commercial bank or other financial institution, appointed by the issuing firm to represent the rights of the bondholders.

Lease

a contractual arrangement by which the lessor (owner) provides the lessee (user) the right to use an asset for a specified period of time.

Private Placement

To keep costs down, the issuing company may choose to sell the debt securities directly to a single investor, such as a large investment fund or an insurance company Issue costs for private placements are lower because these bonds are not subject to the costly and lengthy process of registering with the SEC that is required of all public offerings

Sinking Fund

a designated fund to which an organization makes payments each year over the life of its outstanding debt.

Unsecured Bonds

also referred to as debentures, are not backed by a specific asset. These bonds are secured only by the "full faith and credit" of the borrower

Return on Equity

indicates their ability to generate earnings from the resources that owners provide

Return on Assets

measures the amount of income generated for each dollar invested in assets.

What is the equation for return on assets?

net income/ average total assets

Capital Leases

occur when the lessee essentially buys an asset and borrows the money through a lease to pay for the asset.

Default Risk

possibility that a company will be unable to pay the bond's face amount or interest payments as they become due. As a company's default risk increases, investors demand a higher market interest rate on their bond investments.

An amortization schedule

provides a convenient summary of the cash interest payments, interest expense, and changes in carrying value for each semiannual interest period

Callable Bonds

redeemable bonds. This feature allows the borrower to repay the bonds before their scheduled maturity date at a specified call price. The call price is stated in the bond contract and usually exceeds the bond's face amount. A call feature helps protect the borrower against future decreases in interest rates. benefit both the borrower

Term Bonds

require payment of the full principal amount of the bond at a single maturity date (the end of the loan term).

Serial Bonds

require payments in installments over a series of years.

Carrying Value

the balance in the Bonds Payable account

Premium

the issue price of a bond is above its face amount.

States Interest Rate

the rate quoted in the bond contract used to calculate the cash payments for interest.

What is the debt to equity ratio?

total liabilities/ stockholders equity

Times Interest Earned ratio equation?

(Net income + Interest Expense + Tax Expense) / Interest Expense

recording bonds issued at a discount

(debit) cash (credit) bonds payable

Recording bonds at face value

(debit) cash (credit) bonds payable then (debit) interest expense (credit)cash

2 types of leases

1. Operating 2. Capital

3 primary sources of long-term debt financing

1. bonds 2. notes 3. leases

Why lease rather than buy?

1. leasing improves cash flows through up to 100% financing 2. Leasing improves the balance sheet by reducing long-term debt 3. :easing can lower income taxes

Bonds

A formal debt instrument that obligates the borrower to repay a stated amount, referred to as the principal or face amount, at a specified maturity date. The borrower pays an interest over the life of the bond A lot like notes payable Bonds provide a way to borrow the money needed from many community members, each willing to lend a small amount.

Which long-term debt for financing is the most popular one?

Bonds

Discount

Bonds issued below face amount

Debt Financing

Borrowing money Liabilities Right side of the accounting equation

How do you measure a company's risk?

Debt to equity ratio