Financing Part I: Debt

Chapter 14 in SpicelandSee example excel files

examplesFile names: Bonds and Leases

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Topics: Liabilities

Notes Bonds Leases Current portion of non-current

liabilities Non-current liabilities expected to be

refinanced

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Non Current Liabilities:

Notes ( longer than one year) Mortgage notes Car loan

Bonds

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Bonds:

Types Terms Issuance

Calculation of price Rules

Interest determination Retirement

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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

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

rate Issue price Premium - discount

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Bonds: Issue Price:

1. Maturity value * Coupon rate = interest payment I.e., (100,000 * .1 = $10,000

2. Bond interest paid semi-annually --- interest payment/2 I.e., ($10,000/2 = $ 5,000

3. 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 price6. Difference between maturity value and issue

price = Premium or (discount)

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Issue Price Example (1):Maturity value = $100,000; coupon rate = 10%; term: 10 years; discount rate: 8%

100,000 *PV(4%, 20) = .45639 = $ 45,639

100,000 * .1/2 =

$5,000 *PVA(20,4%) = 13.59033 = 67,952

Issue Price $113,591

Dr. Cash $113,591

cr. Bonds payable $100,000

Cr. Premium $ 13,591

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Issue Price Example (2):Maturity value = $100,000; coupon rate = 10%; term: 10 years; discount rate: 12%

100,000 *PV(6%, 20) = . .31180 = $ 31,180

100,000 * .1/2 =

$5,000 *PVA(20,6%) = 11.46992 = 57,350

Issue Price $ 88,530

Dr. Cash $ 88,530

Dr. discount $ 11,470

cr. Bonds payable $100,000

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Amortization of Premium

Carrying value (CV)

Interest rate

Interest expense

Interest paid

Reduction in CV

113,591 .04 4.544 5000 (456)

113,134 .04 4.525 5000 (475)

112,660 .04 4.506 5000 (513)

100,962 .04 4,038 5000 (962)

100,000

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Amortization of Discount

Carrying value (CV)

Interest rate

Interest expense

Interest paid

Reduction in CV

88,530 .06 5,312 5000 312

88,841 .06 5,330 5000 330

89,172 .06 5,350 5000 350

99,057 .06 5,943 5000 943

100,000

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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

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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

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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

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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

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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

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Current Portion of Long Term Debt

Needs to be reclassified from non-current to current – However:

If company has both the intent and the ability to refinance then separate category between current and non-current