CH 9 Flashcards
Why do companies require financial opitions
to create growth for company
Define debt financing
obtaining additional funding from lenders
define equity financing
obtaining addiction funding from stockholders
define capital structure
the mixtures of liabilities and stockholder’s equity in a business
How do you determine a company’s capital structure
balance sheet
why would a company choose to borrow money rather than issue additional stock in the company
a. taxes
b. interest expense incurred when borrowing money is tax deductible whereas dividends paid to stockholders are not deductible
debt financing’s advantage is that interest on borrowed funds can be tax deductible?
yes
What are three primary sources of long term debt that companies rely on
a. bonds
b. notes
c. leases
are bonds the most common form of corporate debt
yes
Do medium and large corporations often choose to borrow cash by issuing bonds
yes
What is most popular method of financing
leasing
Define a bond
a. 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.
Does the borrower of a bond have to pay interest
yes
are bonds very different from notes payable?
no, they are similar, mostly
Define private placement
Sale of debt securities directed to a single investor
Why do some companies issue bonds rather than borrow money directly from a band
a. bypass bank
b. bonds have a lower interest rate
company’s’ cost of borrowing bonds expensive?
yes
When a bond is issued, does it break down a large debt into manageable parts
yes, is practical for investors to pay interest
Define bond indenture
A contract between a firm issuing bonds and the corporation or individual who purchase the bonds
Are most bonds secured
no, only unsecured
Define unsecured bonds
Bonds that require payment of the full principal amount of the bond at a single maturity date
Does sinking fund set aside money to pay for term bonds
yes
Define sinking fund
bonds that require payment of the principal amount of the bond over a series of maturity dates
What are most commonly used bonds
term bonds
When do you redeem bonds
when the market value is lower than company’s interest rate.
Define callable
A bond feature that allows the borrower to repay the bonds before their scheduled maturity date at a specified call price
Define call price
stated in teh bond contract and usually exceeds the bond’s face amount
What does call price do for a bond
Protects the price of the bond by having the borrower repurchase the high interest rate of the bond at a fixed price and issue new bonds at the new, lower interest rate.
Who benefits from convertible bonds
a. borrower
b. lender
Define convertible bonds
A bond feature that allows the lender ( or investor) to convert each bond into specified number of shares of common stock
How do you convert a bond into 20 shares of common stock
convertible bond = 1000
20 shares
so, 1000/20 = 50 per share
Say the price of 20 shares is 60 ( original 50). What is the new cost of bond?
20*60= 1200
Are bonds pay interest every quarter
a. no, half a year
b. ex=100000.071/2
How do you price a bond
Represents the true interest rate used by investors to value a bond
Define stated interest rate
The rate quoted in the bond contract used to calculate the cash payments
How do you calculate market interest rate each period of a bond
Market interest rate = .07
semiannual periods = 2
.07/2
How do you calculate periods to maturity
total years before maturity= 10
periods each year = 2
=10*2=20
How do you use present value tables for pricing bonds
identify
market interest rate = i
year until maternity = n
Define default risk
The risk that a company will be unable to pay the bond’s face amount or interest payments as it becomes due
When a company cannot pay their interest payments, the investors want…..
higher market interest rate, so they pay a lower bond issue price
What does “ issued at 93,2” mean for bonds
face price of 93200
Define discount
a bond’s issue price is below the face amount
Define premium
a bond’s issue price is above the face amount
Define carrying value
The balance in the bonds payable account which equals the face value of bond payable minus the discount or face value plus premium
How do you journalize bonds issued at face value
a. (dr) cash
b. (cr) Bonds payable
c. (issue bonds at face value)
How do you journalize bond for payment of semiannual interest
a. ( Dr) interest expense
b. (CR) cash
c. (pay semiannual interest)
How do you journalize a discount for bonds
a. (DR) Cash
b. (CR) bond payable ( carrying value)
c. (issue bonds at a discount)
Define net method
preferred method of reporting to IFRS
discount or premium as part of the carrying value of bond pauable
Define IFRS
International financial reporting standards
How do you calculate interest expense
Carrying value * market interest rate per period
How do you journalize semiannual interest
a. (DR) interest expense
b. (CR) bonds payable( difference of cash and interest exp)
c. (CR) cash
d. (pay semiannual interest)
When does interest expense increase
Carrying value of debt issued at a discount
Define Amortization schedule
Provides a summary of the cash interest payments, interest expense, and changes in carrying value for debt instruments
Is the carrying value of bonds payable ,reported on the balance sheet, is worth of bonds.
yes
How do you journalize premiums
a. { DR) interest expense
b. (DR) bonds payable
c. (CR) cash
d. ( pay semiannual interest with premium)
Define amortization schedule
provides a summary of the cash interest payments, interest expense, and changes in carrying value for debt instruments
Define retirement
Corporation buys back bonds from investors
How do you journalize bonds at maturity
a. (DR) bonds payable
b. (CR) Cash
c. ( retire bonds at maturity)
Are losses and gains , during early extinguishment of debt, are reported as non-operating items?
yes
Define installment payment
includes both an amount that represents interest and an amount that represents interest and an amount that represents a reduction of the outstanding balance
Define lease
A contractual arrangement by which the lessor provides the leassee the right to use an asset for a specified period of time
What are two types of leases
a. operating leases
b. capital leases
Define operating leases
Contract in which lessor owns the asset and the lessee simply uses the asset temporily
Define capital leases
Contract in which lessee essentially buys as asset and borrows the money through a lease to pay for the asset
What are the three benefits of leasing
a. improves cash flows up to 100 financing
b. improves the balance sheet by reducing long term debt
c. con lower income taxes
Are leases commitments journalized as liabilities?
no, only in financial statements
Define debt to equity ratio
total liabilities divided by total stockholders’ equity; measures a company’s risk
more debt; risk increases. Except for stockholder’s equity from excessing borrowing
Define return on equity
net income divided by average stockholder’s equity measures the income generated per dollar of equity
Does leverage increase risk
Yes
Define times interest earned ratio
Ratio that compares interest expense with income available to pay those charges
Ni+interest exp+tax exp/interest exp
Define secured bonds
bonds that are supported by specific assets pledged as collateral
Bonds are issued less frequently that than notes
no, bonds are issued more frequent
Define term bonds
bonds that require payment of the full principle amount of the bond at a single maturity date
Define Serial bonds
a. Bonds that require payment of the principal amount of the bond over a series of maturity dates.
Define market interest rate
a. Represents the true interest rate used by investors to value a bond
When do bonds equal face amount
a. When carrying value equals their face amount
Define early extinguishment of debt
a. The issuer retires debt before its scheduled maturity date
When interest rates go down, bond prices go down?
false, bond prices go up
How do you journalize a discount when retire a bond
a. (DR) bonds payable
b. (DR) loss
c. (CR) cash
