Financing Part I: Debt Chapter 14 in Spiceland See example excel files examplesexamples File names: Bonds and Leases.

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Presentation transcript:

Financing Part I: Debt Chapter 14 in Spiceland See example excel files examplesexamples File names: Bonds and Leases

2 Topics: Liabilities Notes Bonds Leases Current portion of non-current liabilities Non-current liabilities expected to be refinanced

3 Non Current Liabilities: Notes ( longer than one year) Mortgage notes Car loan Bonds

4 Bonds: Types Terms Issuance Calculation of price Rules Interest determination Retirement

5 Bonds (Types): Bearer Bonds - Registered bonds Callable bonds Convertible bonds Coupon bonds - Zero coupon bonds Debenture bonds Mortgage bonds Serial bonds Junk bonds – Deep discount bonds

6 Bonds (Terms): Indenture document – bond covenant Underwriters Face value - Maturity value Coupon rate Discount rate - yield rate – effective rate Issue price Premium - discount

7 Bonds: Issue Price: 1. Maturity value * Coupon rate = interest payment I.e., (100,000 *.1 = $10, Bond interest paid semi-annually ---  interest payment/2 I.e., ($10,000/2 = $ 5, Discount Maturity value using discount rate: $100,000 * PV (r, i) 4. Discount interest payments: $5,000*PVA(r.i) 5. PV of maturity value + PV of interest payments = Issue price 6. Difference between maturity value and issue price = Premium or (discount)

8 Issue Price Example (1): Maturity value = $100,000; coupon rate = 10%; term: 10 years; discount rate: 8% 100,000 *PV(4%, 20) = = $ 45, ,000 *.1/2 = $5,000 *PVA(20,4%) = = 67,952 Issue Price $113,591 Dr. Cash $113,591 cr. Bonds payable$100,000 Cr. Premium$ 13,591

9 Issue Price Example (2): Maturity value = $100,000; coupon rate = 10%; term: 10 years; discount rate: 12% 100,000 *PV(6%, 20) = = $ 31, ,000 *.1/2 = $5,000 *PVA(20,6%) = = 57,350 Issue Price $ 88,530 Dr. Cash $ 88,530 Dr. discount $ 11,470 cr. Bonds payable$100,000

10 Amortization of Premium Carrying value (CV) Interest rate Interest expense Interest paid Reduction in CV 113, (456) 113, (475) 112, (513) 100, , (962) 100,000

11 Amortization of Discount Carrying value (CV) Interest rate Interest expense Interest paid Reduction in CV 88, , , , , , , , ,000

12 Retirement at Maturity Final interest payment: Dr. Interest expense$5,943 Cr. Discount$ 943 Cr. Cash$ 5,000 Payment of Maturity Value: Dr. Bond payable$100,000 Cr. Cash$100,000

13 Repurchase After 5 Years Bond market value: $ 97,000, carrying value: $92,112 ) (cash includes $5,000 for interest payment) Dr. Interest expense $ 5,527 Dr. Bond payable $ 100,000 Dr. loss on early retirement $ 3,834 Cr. Discount $ 7,361 Cr. Cash$ 102,000

14 Called After 5 Years Bond market value: $ 106,000, carrying value: $92,112; Called at: 101 (% of maturity value)(cash includes $5,000 for interest payment) Dr. Interest expense $ 5,527 Dr. Bond payable $ 100,000 Dr. loss on early retirement $ 7,834 Cr. Discount $ 7,361 Cr. Cash$ 106,000

15 Converted After 5 Years Bond market value: $ 97,000, carrying value: $92,112; converted into common stock. Dr. Interest expense $ 5,527 Dr. Bond payable$ 100,000 Cr. Discount$ 7,361 Cr. Cash$ 5,000 Cr. Common Stock$ 93,166

16 Early Retirement: Gain or loss used to be treated as an extraordinary event (FAS 4) No longer the case  FAS 145: now early retirement leads to ordinary gain or loss

17 Current Portion of Long Term Debt Needs to be reclassified from noncurrent to current – However: If company has both the intent and the ability to refinance then separate category between current and non-current