Question 1

Which of the following is the best reason for the issuance of long-term liabilities?

Accepted Answer

Debt financing offers an income tax advantage because the interest payments on debt are tax-deductible, reducing the overall taxable income of the firm. This can make long-term liabilities an attractive option for raising capital.

Question 2

In which of the following situations will the book value of a bond be equal to its maturity value?

Accepted Answer

The book value of a bond will be equal to its maturity value when the yield rate equals the contract rate, which is the rate stated when the bond is issued. In this situation, there is no premium or discount on the bond, and the book value is simply the face value or maturity value.

Question 3

For which of the following types of bonds is interest expense recognized each year even though no interest is paid?

Accepted Answer

Zero-coupon bonds are issued at a discount and do not make periodic interest payments. Instead, the interest is added to the bond's face value and paid at maturity. However, because the interest is accruing over the life of the bond, the issuer must recognize an imputed interest expense each year, based on the prevailing market interest rate. This is known as the bond's imputed interest, and it is recognized as an expense on the issuer's income statement, even though no cash payment is made.

Question 4

On January 1, 2010, Tiger Corporation sold $100, 000 of its 15%, five-year bonds dated January 1, 2010, for $102, 000 total cash.The bonds sold at

Accepted Answer

The bonds were sold for $102,000 which is $2,000 more than their face value of $100,000. This means that the bonds were sold at a premium, which is common for bonds that have a higher interest rate than the current market rate. The premium represents the additional amount investors are willing to pay for a bond with a higher interest rate.

Question 5

If a company sells its bonds at less than face value, the effective interest rate is

Accepted Answer

If a company sells its bonds at less than face value, the effective interest rate will be higher than the contract interest rate. This is because the bondholders will receive the face value upon maturity, but they paid a lower amount to purchase the bond initially. This means that the interest payments they receive over the life of the bond will represent a higher percentage return on their investment than the contract interest rate would suggest.

Question 6

When the market rate of interest is less than the contract rate of interest, the bonds should sell at

Accepted Answer

When the market rate of interest is lower than the contract rate of interest on bonds, the bonds are more attractive to investors because they offer a higher return compared to the current market rate. Therefore, the bonds will sell for more than their face value, which is referred to as selling at a premium.

Question 7

If a company sells its bonds at more than face value, the effective interest rate is

Accepted Answer

When bonds are sold at more than face value, it indicates that the market interest rate is lower than the contract interest rate, making the effective interest rate less than the contract interest rate.

Question 8

When the market rate of interest is greater than the contract rate of interest, the bonds should sell at

Accepted Answer

When the market rate of interest is greater than the contract rate of interest, it means that investors can earn a higher rate of return by investing in bonds with higher market rates. As a result, they are less likely to be interested in purchasing bonds with a lower contract rate, causing the bonds to sell at a discount (below par value) in order to compensate for the lower return.

Question 9

Which of the following statements is not true?

Accepted Answer

Historically, equity financing has a higher cost than debt financing. This is because equity investors expect a higher rate of return to compensate for the higher risk they take on.

Question 10

Which of the following is always equal to the face rate of interest?

Accepted Answer

The face rate of interest is also known as the nominal rate, which is the stated interest rate on a financial instrument. It is always equal to itself and does not take into account any compounding or other fees. The effective rate, yield rate, and market rate may be different from the nominal rate depending on factors such as compounding frequency and market conditions.

Question 11

Which of the following may not be equal to the contract rate of interest?

Accepted Answer

The effective rate takes into account the compounding of interest, whereas the contract rate may not reflect this. Therefore, the effective rate may be higher or lower than the contract rate. The stated rate, nominal rate, and face rate are all synonyms for the contract rate and are equivalent.

Question 12

An unsecured bond is called a

Accepted Answer

An unsecured bond that is not backed by any collateral is called a debenture bond. This type of bond relies solely on the creditworthiness and reputation of the issuer to attract investors. Mortgage bonds are backed by specific assets, such as property or equipment. Registered bonds are typically not tied to collateral, but refer instead to whether the bond is issued in the name of the holder or stored electronically. Serial bonds are bonds that are issued with staggered maturity dates.

Question 13

When the market rate of interest is equal to the contract rate of interest, the bonds should sell at

Accepted Answer

When the market rate of interest is equal to the contract rate of interest, the bond should sell at par (face value) because investors will be indifferent between buying the bond at par or investing their money elsewhere at the same rate of return. Therefore, there is no need for the bond to sell at a premium or a discount. An inflation-adjusted discount may occur if the bond's contract rate of interest is not adjusted for inflation and inflation has reduced the bond's purchasing power. A discount may occur if the contract rate of interest is lower than the market rate of interest, making the bond less attractive to investors.

Question 14

When is interest expense less than interest paid?

Accepted Answer

When bonds are sold at a premium, the company receives more cash than the face value of the bonds. As a result, the interest paid will be higher than the interest expense, as the interest expense is calculated based on the face value of the bonds while the interest paid is calculated based on the actual cash paid out.

Question 15

Discount on Bonds Payable is a(n)

Accepted Answer

Discount on Bonds Payable is a contra account because it has a credit balance and is used to reduce the carrying value of bonds payable on the balance sheet.

Question 16

If a company sells its bonds at face value, the effective interest rate is

Accepted Answer

If a company sells its bonds at face value, meaning they sell the bonds for the exact amount stated on the bond, then the effective interest rate will be equal to the contract interest rate. This is because there is no discount or premium involved in the sale of the bonds.

Question 17

Which of the following is not a reason for the issuance of long-term liabilities?

Accepted Answer

Long-term liabilities are typically issued to raise funds for a business's operations or expansion. A is correct because the interest paid on debt is tax-deductible, making it a more attractive option for financing than issuing equity. C is correct because in some cases, debt may be the only viable option for businesses with limited access to equity or other sources of funding. D is correct because debt financing may be less expensive than equity financing due to a lower cost of capital. However, ownership interest is not a reason for issuing long-term liabilities, as this refers to equity and not debt.

Question 18

Leverage occurs when a company's

Accepted Answer

Leverage occurs when a company's rate of return exceeds its interest payments. This means that the company is able to generate more profits than it has to pay in interest on its debt, which can lead to increased financial stability and growth opportunities. A and D do not accurately describe leverage, and B describes a scenario where the company is just breaking even on its debt.

Question 19

Which of the following is not another term for the true rate or cost of borrowing considering compound interest?

Accepted Answer

The nominal rate is the stated interest rate without taking compounding into account, whereas the effective rate, market rate, and yield consider the effects of compounding.

Question 20

Which of the following bonds pay no interest until maturity?

Accepted Answer

Zero-coupon bonds, also known as discount bonds, are bonds that pay no interest until maturity. Instead of periodic interest payments, these bonds are issued at a deep discount to their face value and then redeemed for the full face value at maturity. This means that the investor earns interest in the form of the difference between the purchase price and the face value of the bond.

Quiz 14: Long-Term Liabilities and Receivables