Long Term Liabilities

 Capital Structure  Debt Financing - Bonds ◦ Interest is tax deductible  Equity Financing - Stocks ◦ Dividends paid is not tax deductible

 Same as Note Payable  Note is to one lender  Bonds are to several lenders  Interest is paid every 6 months – twice a year  Usually 20 plus years  Bonds sold for capital expenditures  Sold to the public or to Large banks (underwrite) for a fee

 Indenture – characteristics of bond  Principle – Face Amount  Interest - paid over life of the bond  Sinking Fund- payments of principle to acct  Secured or unsecured (debentures)  Term or serial – all at once or installments  Callable (redeemable)– borrower can call it back  Convertible – lender can change it to stock

 Bond terminology

 Issue Price of Bond ◦ Present Value of Principle (Face Amount) $1 ◦ plus ◦ Present Value of Interest payments $1 Annuity ◦ When interest is paid semi annual interest rate is half and time is double ◦ Use the same time and % for both principle and interest ◦ Market Interest Rate is how to rate the value of the bond ◦ Stated Interest Rate is what you use for interest payment and is stated on the bond

 The higher the market interest rate, the lower the bond issue price will be.  The lower the market interest rate, the higher the bond issue price will be.

 $100,000 bond issued, 10 years,  Stated Interest 7%, Market Interest 7% (same)  Face Amount$100,000  Interest Payments-6months 3,500  Market Interest (7%/2)3.5%  Number of Periods (10yrs X2)20periods

 Table :  Face Value * multiplier $1 3.5% and 20 periods  Interest Payment * $1 annuity 3.5% and 20 periods  $ * =  $3,500 * =  Issue Price   Excel:  PV(Market%,#periods,Interest payment, Face amount,0)  PV(.035,20,3500,100000,0)

 FV= $  PMT= 3,500  I/yr = 3.5  N = 20  Press PV  BE 9-2 pg 443

 Issue Bond  Cash  Bonds Pay  Pay Interest Expense  Interest Expense3500  Cash 3500

 $100,000 bond issued, 10 years,  Stated Interest 7%, Market Interest 8%  Face Amount$100,000  Interest Payments-6months 3,500  Market Interest (8%/2)4.0%  Number of Periods (10yrs X2)20periods

 Table :  Face Value * multiplier $1 4.0% and 20 periods  Interest Payment * $1 annuity 4.0% and 20 periods  $ * =  $3,500 * =  Issue Price   Excel:  PV(Market%,#periods,Interest payment, Face amount,0)  PV(.04,20,3500,100000,0)

 FV= $  PMT= 3,500  I/yr = 4.0  N = 20  Press PV  BE 9-3 pg 443

 Issue Bond  Cash93205  Bonds Pay93295  Pay Interest Expense ( 1 st 6 months)  Interest Expense3728 (93205*4%)  Bonds Payable 228  Cash 3500  Pay Interest Expense (2 nd 6 months)  Interest Expense3737 ( *4%)  Bonds Payable 237  Cash 3500

 Date  Interest Paid (Cash)  Interest Expense  Increase in Carrying Value  Carrying Value  Pg 426

 $100,000 bond issued, 10 years,  Stated Interest 7%, Market Interest 6%  Face Amount$100,000  Interest Payments-6months 3,500  Market Interest (6%/2)3.0%  Number of Periods (10yrs X2)20periods

 Table :  Face Value * multiplier $1 3.0% and 20 periods  Interest Payment * $1 annuity 3.0% and 20 periods  $ * =  $3,500 * =  Issue Price 107,439   Excel:  PV(Market%,#periods,Interest payment, Face amount,0)  PV(.03,20,3500,100000,0)

 FV= $  PMT= 3,500  I/yr = 3.0  N = 20  Press PV  BE 9-4 pg 443

 Issue Bond  Cash  Bonds Pay  Pay Interest Expense ( 1 st 6 months)  Interest Expense3223 (107439*3%)  Bonds Payable 277  Cash 3500  Pay Interest Expense (2 nd 6 months)  Interest Expense3215 ( *3%)  Bonds Payable 285  Cash 3500

 Date  Interest Paid (Cash)  Interest Expense  Increase in Carrying Value  Carrying Value  Pg 428

 At Maturity  Bond Payable  Cash  Before Maturity -premium  Bond Payable  Loss  Cash

 Fixed Payment  Interest (Rate* principle)  Difference (reduction in principle)  Get Mortgage  Cash  M/P  Make a Payment ◦ Principle ◦ Interest Expense ◦ Cash

 See page 433  BE 9-17 pg 444

 Lessee--User  Lessor--Owner  Lease Contractual agreement for the right to use the asset for a specified time  Operating Leases – rentals  Capital Leases – buying a capital asset

 Debt to Equity  Total Liabilities/ Total SE  Measure of financial leverage  Return on Assets  Net Income/Avg Total Assets ◦ Overall profitability  Return on Equity  Net Income/Avg Total SE ability to generate earnings from resources that owners provide  Times Interest Earned  Net Income+InterestX+Tax X/Interest X  Compares interest expense to net income available to pay interest expense  BE 9-18 pg 444

 Problems A  9-1, 9-2, 9-4, 9-6, 9-7A