Question 1

Which of the following statements is ?

Accepted Answer

Interest on bonds is tax deductible for the issuing company, which reduces the company's taxable income and thus its tax liability.

Question 2

A company borrowed $50,000 cash from the bank and signed a 6-year note at 7%. The present value of an annuity for 6 years at 7% is 4.7665. The annual annuity payments equal:

Accepted Answer

The annual annuity payment can be calculated by dividing the loan amount by the present value of the annuity factor: $50,000 / 4.7665 = $10,489.88.

Question 3

Pitt Corporation's most recent balance sheet reports total assets of $35,000,000 and total liabilities of $17,500,000. Management is considering issuing $5,000,000 of par value bonds (at par) with a maturity date of ten years and a contract rate of 7%. What effect, if any, would issuing the bonds have on the company's debt-to-equity ratio?

Accepted Answer

The debt-to-equity ratio is calculated as total liabilities divided by total equity. Currently, Pitt Corporation's debt-to-equity ratio is 1.0 (17,500,000/17,500,000). If the company issues $5,000,000 of bonds, the total liabilities would increase to $22,500,000 (17,500,000 + 5,000,000). Since the total equity remains the same, the new debt-to-equity ratio would be 1.286 (22,500,000/17,500,000), which is higher than the current ratio of 1.0. Therefore, issuing the bonds would cause the company's debt-to-equity ratio to worsen from 1.0 to 1.286, and the correct answer is B.

Question 4

An advantage of bond financing is:

Accepted Answer

All of the options listed are advantages of bond financing. Bonds do not dilute owners' control since they do not entail giving up any ownership interest, unlike equity financing. The interest payments on bonds are tax-deductible, which can lower the company's taxable income. Bond financing can increase return on equity by leveraging the company's capital structure, assuming the firm earns more on the borrowed funds than it pays in interest. Lastly, trading on the equity refers to the practice of borrowing at a lower rate of interest and investing in assets that yield a higher rate of return, which is facilitated by bond financing.

Question 5

The carrying amount of a long-term note payable:

Accepted Answer

The carrying amount of a long-term note payable is computed as the present value of all remaining future payments, discounted using the market rate of interest at the time of issuance. This is because the carrying amount represents the current value of the future cash payments that the debtor is obligated to make.

Question 6

Which of the following accurately describes a debenture?

Accepted Answer

A debenture is a type of bond that is not collateralized but backed only by the issuer's general credit standing.

Question 7

Bonds that mature at different dates with the result that the entire principal amount is repaid gradually over a number of periods are known as:

Accepted Answer

Serial bonds mature at different dates with the result that the entire principal amount is repaid gradually over a number of periods. This is in contrast to term bonds, where the entire principal amount is repaid on a single maturity date, and to sinking fund bonds, where the issuer makes periodic payments into a sinking fund to accumulate funds that will be used to retire the bonds at maturity. Registered bonds refer to bonds that are issued and registered in the name of the owner, while bearer bonds refer to bonds that are payable to the holder and do not require registration. Callable bonds allow the issuer to redeem the bonds before maturity, typically at a premium to the face value of the bonds.

Question 8

A bondholder that owns a $1,000, 10%, 10-year bond has:

Accepted Answer

A bondholder has the right to receive the face value of the bond at maturity, which in this case is $1,000. Ownership rights, dividends, and the other mentioned cash flows are not correct for a bondholder.

Question 9

To provide security to creditors and to reduce interest costs, bonds and notes payable can be secured by:

Accepted Answer

Bonds and notes payable can be secured by mortgages, which are legal agreements that allow creditors to take possession of a borrower's assets, such as property or equipment, in the event that the borrower defaults on the loan. This provides security to the creditors and reduces the interest costs, as the risk of default is lower with a secured loan.

Question 10

Tart Company's most recent balance sheet reports total assets of $42,000,000, total liabilities of $16,000,000 and shareholders' equity of $26,000,000. Management is considering using $3,000,000 of excess cash to prepay $3,000,000 of outstanding bonds. What effect, if any, would prepaying the bonds have on the company's debt-to-equity ratio?

Accepted Answer

Prepaying $3,000,000 of outstanding bonds would reduce both the company's total liabilities and total assets by $3,000,000. This would change the total liabilities to $13,000,000 and total assets to $39,000,000, with shareholders' equity remaining at $26,000,000. The initial debt-to-equity ratio is $16,000,000 / $26,000,000 = 0.615 (approximately .62). After prepaying the debt, the new debt-to-equity ratio would be $13,000,000 / $26,000,000 = 0.5. Therefore, prepaying the debt improves the debt-to-equity ratio from .62 to .50.

Question 11

The carrying amount of bonds at maturity is always equal to:

Accepted Answer

The carrying amount of bonds at maturity is always equal to the par value that the issuer pays the holder, as all discounts or premiums are fully amortized by the maturity date, and the bond is redeemed at its par (or face) value.

Question 12

The debt-to-equity ratio:

Accepted Answer

The debt-to-equity ratio is a financial ratio that compares a company's total outstanding debt to its total equity. It is a means of assessing the risk of a company's financing structure, as it indicates the extent to which a company is relying on debt to finance its operations.

Question 13

Collateral agreements for a note or bond can:

Accepted Answer

Collateral agreements provide security for lenders by offering a specific asset or set of assets that can be used to repay the debt in the event that the borrower defaults. This decreases the risk associated with the loan and can lead to a lower interest rate for the borrower.

Question 14

A company must repay the bank a single payment of $10,000 cash in 3 years for a loan it entered into. The loan is at 8% interest compounded annually. The present value factor for 3 years at 8% is 0.7938. The present value of the loan is:

Accepted Answer

Present value = Future value / (1+interest rate)^time period
Present value = 10,000 / (1+0.08)^3
Present value = 10,000 / 1.2597
Present value = $7,938.

Question 15

A disadvantage of bonds is:

Accepted Answer

All of the given options are disadvantages of bonds. Bonds require payment of periodic interest, which reduces the amount of funds available to the issuer for other purposes. The payment of par value at maturity may be difficult for the issuer if the bond proceeds were invested in projects with insufficient returns. Bonds can decrease the return on equity, especially if the company borrows too much and cannot generate enough profits to cover the interest and principal payments. Moreover, if a company's income and cash flow decrease, it may find it burdensome to make bond payments, resulting in default or bankruptcy.

Question 16

A company purchased equipment and signed a 7-year installment loan at 9% annual interest. The annual payments equal $9,000. The present value of an annuity for 7 years at 9% is 5.0330. The present value of the loan is:

Accepted Answer

The present value of the loan is calculated by multiplying the annual payment by the present value of an annuity factor: $9,000 * 5.0330 = $45,297.

Question 17

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

Accepted Answer

Installment notes require the issuer to make a series of payments consisting of both interest and principal. Debentures are long-term bonds issued without collateral, discounted notes are sold at a discount to face value, indentures are legal agreements between the issuer and bondholders, and there is no financial instrument called an investment note.

Question 18

A company's total liabilities divided by its total shareholders' equity is called the:

Accepted Answer

The definition given in the question matches the formula for the debt-to-equity ratio, which is calculated by dividing total liabilities by total shareholders' equity. Therefore, the correct answer is D.

Question 19

The party that has the right to exercise the call option on callable bonds is (are):

Accepted Answer

The bond issuer has the right to exercise the call option on callable bonds. Callable bonds have a call option that allows the issuer to redeem the bond before maturity. This option provides the issuer with flexibility to refinance debt at a lower cost if interest rates have declined.

Question 20

A company borrowed cash from the bank by signing a 5-year, 8% installment note. The present value of an annuity at 8% for 5 years is 3.9927. Each annuity payment equals $75,137.13. The present value of the note is:

Accepted Answer

The present value of the note is calculated by multiplying the annual payment by the present value of an annuity factor. Here, $75,137.13 * 3.9927 = $300,000.00.

Quiz 14: Long-Term Liabilities