Planning Debt Financing Chapter 14 Planning Debt Financing

Debt Financing Terms Maker of Note = borrower Holder of Note = lender Face Value of Note = what the borrower will ultimately pay the lender Face Rate of Note = cash interest the borrower will periodically pay the lender Effective Interest Rate = actual interest rate charged on the note Proceeds of Note = amount of cash raised from the issuance of the note.

What are the 3 Basic Types of Notes? Periodic Payment Note Installment note Borrower receives the face value and makes periodic payments of principal and interest PV = amount borrowed, FV = 0, r = annual rate of interest, c = number of payments per year, n = total number of payments, determine ANN = amount of each payment

Basic Notes Continued Lump-sum payment note Noninterest-bearing note Borrower receives an amount less than the face value of the note and repays the face value of the note at some point in the future PV = amount received, c = number of compounding periods per year, n = total number of compounding periods, r = annual rate of interest, ANN = 0, determine FV = face value of note

Basic Notes Continued Periodic and lump-sum payment note Interest-bearing note Borrower makes 2 promises: (1) repay the face amount of the note at some point in the future and (2) pay interest based on the face amount of the note and the face rate of interest periodically throughout the life of the note Borrower receives more or less than the face value of note depending on the market rate of interest

Periodic and Lump-sum Payment Note Continued FV = face value (amount repaid at end), ANN = interest paid periodically (face value * face rate * time), r = market rate of interest (annually), c = number of interest payments per year, n = total number of interest payments, determine PV = amount received

How do Notes Impact Budgeted Financial Statements? Income statement Interest expense (also tax expense—beyond the scope of this text) Statement of cash flows Cash paid periodically and at the end Balance sheet Carrying value of the note

Budgeted Financial Statements: Installment Notes Income statement Interest expense decreases over time because we are paying principal and interest with every payment, therefore, the principal on which interest is based decreases over time Statement of cash flows Payment of principal and interest is constant over time Balance sheet Carrying value of the note decreases over time because we are making principal payments over the life of the note

Budgeted Financial Statements: Noninterest-bearing Notes Income statement Interest expense increases over time because interest accrues but is not paid over the life of the note (carrying value increases) Statement of cash flows No periodic payment made Balance sheet Carrying value of the note increases over time as the interest incurred, but not paid, is added to the carrying value of the note

Budgeted Financial Statements: Interest-bearing Notes (Market Rate greater than Face Rate) Income statement Interest expense increases over time because we are making payments based on the face rate of interest when the market rate of interest is higher, therefore, the additional interest accrues over the life of the note Statement of cash flows Cash payment of interest is constant over time Balance sheet The carrying value of the note increases over time as the interest accrued, but not paid, is added to the carrying value

Budgeted Financial Statements: Interest-bearing Notes (Market Rate less than Face Rate) Income statement Interest expense decreases over time because we are making payments based on the face rate of interest when the market rate of interest is lower, therefore, the reduction in interest accrues over the life of the note Statement of cash flows Cash payment of interest is constant over time Balance sheet The carrying value of the note decreases over time as the reduction in interest is subtracted from the carrying value

What are the Most Common Sources of Debt Financing? Private financing Borrowing from financial institutions Leasing Public financing Issuing bonds

What are the Most Common Types of Bonds? Registered Callable Convertible Serial Secured Subordinated