Chapter 10: Bonds Payable Flashcards
Advantages Bonds Payable
- stockholders maintain control because bondholders do not vote or share in any dividend purchases
- a portion of interest expense is tax deductible which reduces cost of net borrowing
- return to shareholders can be positive if money is borrowed at a low interest rate and invested in projects that ear a high rate
Disadvantages of Bonds Payable
- chance bankruptcy exists –> must pay bond interest payment
- bonds must be paid at specific time in future – - so negative impact on cash flow
- must pay back or refinance debt
Cash Payments of Bond
- payment of interest over its life
- principal value at maturity date
principal value aka
face, par, maturity
coupon rate aka
stated, contract, nominal
When is the coupon rate used
compute interest payments (Face Bond Value x Coupon Rate)
Early Retirement of Bonds
- some have a call feature that allows the issuing company to call (retrieve) the bonds early
- most often requires the issuing company to pay investors an amount greater than the bond’s face value to retire before maturity date
Book Value > cash paid to retire bond
gain
what is the book value
sum of all shareholders equity on BS
Why would a company retire a bond by purchasing an open market
- if no call feature available
- good when cost this < cost premium
Times Interest Earned Shows
if company is generating sufficient resources from its profit-making operations to meet its current obligations
High Times Interest Earned =
extra margin of protection if profitability declines
(failure to meet required interest payments could result in bankruptcy)
Debt Equity HIgh =
company relies heavily on debt financing (relative to equity financing)
Risk: company might not be able to meet its contractual financial obligations during business downturn
Low Ratio: more equity
what is equity
what does the debt-equity ratio show
