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Comm 217 > chapter 10: long term liabilities > Flashcards

chapter 10: long term liabilities Flashcards

1
Q

to which type of companies are long term liabilities advantageous?

A

companies in which:

shareholders maintain control

interest expense is tax deductible

the impact of earnings Is positive

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2
Q

what are the major disadvantages associated with long term debt?

A

risk of bankruptcy

negative impacts on cash flow (management must be able to repay the cash they borrowed without it hindering the cash they have)

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3
Q

what is the typical form of a single lender debt?

A

note payable

mortgage note payable

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4
Q

what is the typical form of a multiple lender debt

A

typically in the form of a debenture or a bond

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5
Q

what is a private placement?

A

having long term debt to pay to:

banks

insurance companies

pension fund companies

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6
Q

what are bonds and debentures used for?

A

obtain large sum of long term loan that cannot be lent by one single creditor

you have multiple creditors giving you the loan

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7
Q

what are the most common maturity dates for long term notes and loans?

A

usually 5 years or less

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8
Q

what are the most common maturity dates for mortgages?

A

usually exceeding 25 years

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9
Q

what is the general meaning of debt?

A

funds from creditors

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10
Q

what is the general meaning of equity?

A

funds from shareholders

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11
Q

what does it mean for a loan to be secured?

A

they have collaterals that can be liquidated in order to pay back the money they owe you if company that owes you goes broke

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12
Q

unsecured loan

A

you have no collateral, if they cant pay you, you lose the money

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13
Q

are bonds a secure loan or unsecured loan?

A

its secured

it means if you can’t pay up, you’re going to have to liquidate and pay them assets or cash form liquidation

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14
Q

are debentures a secure loan or unsecured loan?

A

they are not securitized

if somebody can’t pay, rip you

they are basically an unsecured bond

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15
Q

do bonds have interest to be also paid?

A

yeee

it is paid through principal at maturity

you pay interest and full amount

stated rate of interest always specified

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16
Q

what is a bond principal

A

the amount you have to pay at due date + periodic interest cash payments

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17
Q

what is the par value and face amount?

A

other names for bond principal or maturity value of bond

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18
Q

stated rate of interest

A

rate of interest per period specified in contract

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19
Q

what is a callable bond

A

bond may be called for early retirement by the issuer

Callable by the person who issued the contract, callable by company who issued the loan

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20
Q

redeemable bonds

A

You can pay back the loan to avoid paying additional interest

you do this when you don’t need the additional cash that accumulated interest

If you wanna redeem it, you could end up paying some additional interest for breaking the contract

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21
Q

retractable bonds

A

If you are to retract it early, youre not getting the full amount (as the one who gave the loan)

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22
Q

convertible bonds

A

bonds may be converted into common shares by the issuer

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23
Q

what is a bond indenture?

A

bond contract that specifies the legal provisions of bonds

contains covenants designed to protect the creditors

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24
Q

when does a company prepare bond indentures

A

when it issues new bonds

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25
Q

what do typical covenants include

A

energy swords

limitations on new debt that the company might issue in the future

limitations on payments of dividends

required minimum levels of accounting ratios

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26
Q

manager prefer which types of covenants

A

those that glass reach

those that are less restrictive to not reduce company’s future actions

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27
Q

what type of covenants do creditors prefer

A

restrictive covenants to reduce risk of losing their investment

28
Q

where are covenants usually reported

A

in the notes of the financial statements

29
Q

what is a bond certificate

A

the bond document that a bondholder re¡receives when the bond is issued

all bond certificates for a single bond are identical

30
Q

what is the trustee?

A

independent party appointed to represent bondholders

31
Q

firm commitment underwriter

A

buys entires issues of bonds and resells them to individual creditors

32
Q

best efforts underwriter

A

just sells bonds or notes without any obligation to purchase them

33
Q

over-the-counter market (OTC)

A

this is where most bonds are traded

basically, they are traded by telephone

34
Q

default risk of a bond

A

evaluating the a probability that a bond issuer will not be able to meet the requirements specified in the indenture

35
Q

the higher the risk default the higher or lower the interest rate of a bond?

A

the higher the interest rate of a bond

36
Q

what are the two main reasons that bonds change prices?

A

changes in creditworthiness of bond issues

changes in market interests

37
Q

cash interest payments

A

multiplying the principal amount and the interest rate (coupon rate)

38
Q

coupon rate

A

stated rate of interest on bonds

39
Q

the market interest rate

A

the current rate of interest when incurred

also called yield or effective interest rate

40
Q

bond premium

A

the difference between selling price and par

occurs when sold for above par

interest rate higher than market interest rate

41
Q

bond discount

A

the difference between selling price and par

occurs when sold for below par

interest rate lower than market interest rate

42
Q

why are creditors indifferent if a bond is used as par, discount, or premium?

A

because bonds are always priced to provide the market rate of interest

43
Q

how are the effective and stated rate of interest when the present value of the future cash flows associated with a bond is equal to the bond’s par value?

A

the effective and stated rate of interest are equal

44
Q

true or false

companies rarely issue bonds at par

A

true

45
Q

effective interest method

A

amortizes a bond discount, or premium, on the basis of the tinters rate

46
Q

what are the steps to the effective interest method?

A

step 1: compute the interest expense

unpaid balance * effective interes trates * n/12

n = number of months in each interest period

step 2: compute the amortization amount:

amortization of bond discount = interest expense - interest paid (accrued)

amortization of bond premium = interest expense - interest paid (accrued)

47
Q

what do you do you do to discounts or amortization on bonds payable?

A

it adds to the carrying amount of the loan, hence interest expense increases at every period of payment

the carrying amount increases every period, until it goes makes the whole thang equal to the stated price of the bond

48
Q

bonds are recorded at full value of payment or present value?

A

present value with current market rate of interest

49
Q

what is a zero coupon bond

A

bonds that do not pay periodic cash interest

will sell at much less than its maturity value because it does not carry any interest

50
Q

when are bonds sold at premium?

A

when market rate of interest is lower than the bond interest rate

51
Q

when bonds are sole at premium, does the interest expense increase or decrease every period that you have to pay? why?

A

it decreases

the carrying amount of the present value is bigger than future cash flows

so to get to the same amount of future cash flows, the amortization is taken off the carrying amount at every payment instead of added to it

52
Q

when bonds or sold at premium, in every payment, does amortization increase or decrease?

A

they increase as well

instead of adding it to carrying amount, they take it off

53
Q

where is the interest expense reported?

A

in the statement of financial earnings

54
Q

what is the times interest earned ratio?

meaning and formula

A

is the company generating enough ressources (added value) from profit making activities to meet is current obligations associated with debt?

higher ratio is gayer because it is an extra margin of protection in case profitability deteriorates

want to see if you can meet required interest payments and obligations

                               interest expense
55
Q

what could cause the price of a bond to drop?

A

a rise in interest rates

56
Q

what would be the result of repurchasing a bond when interest rates rise?

A

it would result in a gain that increase the company’s net earnings

57
Q

what happens if you decide to retire a bond because of rising interest rates but decide to sell if after at a higher contract interest (not the same as market interest)

A

the gain made on the retirement of the bond would be misleading

company will need to make higher interest payments not the refinanced debt

58
Q

If you decide to retire a bond when market interest rates decrease, what will it result in?

A

a loss on statement of earnings

it will reduce the amount of periodic interest payments

59
Q

what is an operating lease

A

leasing an asset without transferring or risks and rewards to lessee

no liability is recorded when operating lease is created

rent expense is recorded when the use the asset

60
Q

what is a finance lease

A

a lease that transfers all the risks and rewards of ownership from lessor to lessee

you record it as if an asset was purchased

you record the asset and the liability to pay

61
Q

what are the terms to consider a lease a finance lease

A

ownership of the asset is transferred to lessee at end of the lease term

lease contract provides lessee with option to purchase the asset in the future at a price that is expected to be sufficiently lower than its fair market value at the time the option becomes possible to activate

the lease term is a major part of the asset’s economic life even if the title is not transferred

lessee only one that can use assets without any major modifications

present value of the minimum lease payments is substantially all of the fair value of the leased asset when the lease is signed

62
Q

debt to equity ratio

explain and formula

A

to examine company’s financing strategy

to examine how much debt has been used to finance a company’s acquisition of assets in comparison to investments by shareholders

high ratio indicates that they rely heavily on creditors and less from investors

assess the risk that company may not be able to meet its financial obligations during business downturn

debt to equity ratio = total liabilities / shareholder’s equity

63
Q

which more company would prove to be more risky for creditors and investors?

high debt to equity ratio and high interest coverage ratio

low debt to equity ratio and low interest coverage ratio

A

low debt to equity ratio and low interest coverage ratio

any amount of liability can be risky, so even if its small, there is a chance the company can’t pay it

the company with hight interest coverage ratio is viewed as less risky than one with low interest coverage ratio (even if it has high debt to equity ratio)

64
Q

what is the difference between stated interest and the effective rate of interest on a bond?

A

The stated rate of interest is the rate specified on a bond;

it is the basis for determining interest payment to the bondholders

The effective rate of interest is the market rate at which the bonds are selling currently;

it determines the effective overall interest on the bond

65
Q

straight line amortization

A

simplified bond amortization method that allocates an equal amount to each interest period

Comm 217 (18 decks)

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