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Exam 14: Long-Term Liabilities

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Question 111

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An ________ is a series of equal payments at equal time intervals.

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Question 112

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Compounded means that interest during a second period is based on the total amount borrowed plus the interest accrued in the first period.

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Question 113

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Payments on an installment note normally include the accrued interest expense plus a portion of the amount borrowed.

A disadvantage of bond financing is:

________ bonds can be exchanged for a fixed number of shares of the issuing corporation's common stock.

A bond's par value is not necessarily the same as its market value.

On January 1, a company issues bonds dated January 1 with a par value of $400,000. The bonds mature in 5 years. The contract rate is 7%, and interest is paid semiannually on June 30 and December 31. The market rate is 8% and the bonds are sold for $383,793. -The journal entry to record the first interest payment using the effective interest method of amortization is:

When a bond sells at a premium:

On January 1, $300,000 of par value bonds with a carrying value of $310,000 is converted to 50,000 shares of $5 par value common stock. The entry to record the conversion of the bonds includes all of the following entries except:

On January 1, a company issued and sold a $400,000, 7%, 10-year bond payable, and received proceeds of $396,000. Interest is payable each June 30 and December 31. The company uses the straight-line method to amortize the discount. -The journal entry to record the first interest payment is:

Promissory notes that require the issuer to make a series of payments consisting of both interest and principal are:

The factor for the present value of an annuity at 8% for 10 years is 6.7101. This implies that an annuity of ten $15,000 payments at 8% yields a present value of $2,235.

The factor for the present value of an annuity for 6 years at 10% is 4.3553. This implies that an annuity of six $2,000 payments at 10% is the equivalent of $8,710.60 today.

A corporation plans to invest $1 million in oil exploration. The corporation is considering two plans to raise the money. Under Plan #1, bonds with a contract rate of interest of 6% would be issued. Under Plan #2, 50,000 additional shares of common stock would be issued at $20 per share. The corporation currently has 300,000 shares of stock outstanding, and it expects to earn $700,000 per year before bond interest and income taxes. The net income and return on investment for both plans is shown below: $\begin{array}{|l|c|c|}\hline &\underline{\text { Plan \#1 }} &\underline{\text { Plan \#2 }}\\ \hline \text { Earnings before bond interest and taxes. } & \$ 700,000& \$ 700,000 \\\hline \text { Bond interest expense } & (60,000) &\\\hline \text { Income before } & \$ 640,000&\$700,000 \\\hline\end{array}$ $\begin{array}{|l|c|c|}\hline \text { Income before taxes } & \$ 640,000 & \$ 700,000 \\\hline \text { Income taxes} & (224,000) & (245,000) \\\hline \text { Net income. } & \$ 416,000 & \$ 455,000 \\\hline\\\hline \text { Equity. } & \$ 8,000,000 & \$ 9,000,000 \\\hline \text { Return on Equity. } & 5.2 \% & 5.06 \% \\\hline\end{array}$ Comment on the relative effects of each alternative, including when one form of financing is preferred to another.

A company issued 9.2%, 10-year bonds with a par value of $100,000. Interest is paid semiannually. The annual market interest rate on the issue date was 10%, and the issuer received $95,016 cash for the bonds. The issuer uses the effective interest method for amortization. On the first semiannual interest date, what amount of discount should the issuer amortize?

What are methods that a company may use to retire its bonds?

The debt-to-equity ratio is calculated by dividing total stockholders' equity by total liabilities.

A company has 10%, 20-year bonds outstanding with a par value of $500,000. The company calls the bonds at 96 when the unamortized discount is $24,500. Calculate the gain or loss on the retirement of these bonds.

A company's debt-to-equity ratio was 1.0 at the end of Year 1. By the end of Year 2, it had increased to 1.7. Since the ratio increased from Year 1 to Year 2, the degree of risk in the firm's financing structure decreased during Year 2.

The market rate for bonds is generally higher when the time period to maturity is longer due to the risk of adverse events occurring over the time period.