Lecture 4: BS liabilities - formula, idea

Question 1

which questions do you need to ask to know if a liability is debt or equity

Answer 1

• Does the instrument require the issuer to pay cash?
  If the answer is yes, then it is clearly a liability because it is a future obligation on
  your balance sheet.
• If no cash is needed to be paid, then do we need to transfer any financial
  assets?
  If that is also not required, then clearly it is an equity, because again there is no
  obligation to deliver or to pay.

Question 2

bonds

Answer 2

(long term debt that is issued longer then 10 years)

Bonds are the promises of cash payments a company makes to anyone in exchange for cash today/ An investor buys a bond of a company and holds it for as long as he or she wants. When enough money was earned on the bond, there is a right to exchange bond again with the company for all the money of interest the bonds has collected.

Question 3

Externally to the bond you are holding, there is a market rate

Answer 3

effective interest rate, that defines the
worthiness of the bond and its value.
- If the market rare = coupon rate → bond is valued at par
- If the market rate < coupon rate → premium of the bond because PV > face value pf the bond
o Less is paid at the maturity than borrowed
o Periodic interest payments are REDUCED
- If the market rate > coupon rate → discount because PV < face value

Question 4

Bonds have to components of cash flows:

Answer 4

• Face value = amount will be payable at maturity
• Periodic interest payments = coupon rate

Question 5

PV of future cash payments.

Answer 5

The cash you received today (at the exchange day) is the PV of future cash payments.

Question 6

What is a total cost of finance?

Answer 6

it is charged to the IS during the life of the bond – amortized

Question 7

Residual balance

Answer 7

= paid in capital
- Why so? Because when you are converting the debt, it is allocated to the common stock and becomes paid in capital.

Question 8

Warrants

Answer 8

Warrants are the rights to purchase n number of shares at a certain price in the certain timeframe Since thy are traded on the market, relative market approach is used

Question 9

Financial lease

Answer 9

Financial lease transfers all risks and rewards from the owner to the lessee.

Question 10

Requirements for lease to be financial:

Answer 10

• Transfer of ownership of the asset
• Reasonable certainty that the option to purchase an asset will be exercised
• Lease term is the life of the assets
• Present value is greater than or equal to all fair value of leased assets
• Only the lessee can use the assets without modification
• If cancelled, the lessee has to pay for the loss of the lessor
• Gain or losses from fluctuations of the FV fall to the lessee
• Lessee has the right to continue the lease for the 2nd period

Question 11

PV is

Answer 11

the fixed lease term and any optional terms.
The PV is the depreciated over the shorter of the lease term or the useful life