1. 16 Chapter Long-Term Debt and Lease Financing Revised By: P Chua
Prepared by:
Terry Fegarty
May 4, 2005
McGraw-Hill Ryerson
©2003 McGraw-Hill Ryerson Limited

2. Chapter 16 - Outline Bonds Bond Terminology
PPT 16-2
Chapter 16 - Outline
Bonds
Bond Terminology
Priority of Claims on Bankruptcy
Methods of Retiring (Repaying) Bonds
Reading Bond Price Quotations
3 Types of Bond Yields
Bond Ratings
Other Forms of Bond Financing
Lease vs. Purchase
2 Types of Leases
Advantages/Disadvantages of Debt
Advantages/Disadvantages of Leasing
Summary and Conclusions

3. PPT 16-4
Bonds
Firms and governments “borrow” money from investors by selling bonds
A bond is a written promise that the borrower (firm) will pay the lender (investor) at a stated future date, the principal plus a stated rate of interest
Bonds differ from one another in terms of maturity (payment date), potential yield (interest rate), and investment quality (risk)
Several companies rate the quality of various bonds
Discussed on pages
Notes:
Government bonds: safe investments, but the safety of the investment can be eroded over time for longer terms. Federal bonds are backed by the Canadian government. Typically they are sold in large blocks to institutional investors seeking large amounts of more secure investments to balance their portfolios. Pension funds, banks, insurance companies and private investors also invest in bonds. Municipal bonds (provincial and local governments) sell bonds to raise capital for government projects. Municipal bond interest is not taxable. Banks will invest in bonds near their maturity date as a safe and liquid investment.
Bonds are generally sold through the over-the-counter market, and not traded on an organized exchange.
Activities:
Building Your Business Skills, p.666.
Concluding Case 21-1: Wham! Bang! Pow! The Marvel of Going Public, p.667. 13 13

4. Bond Terminology Par Value: principal or face value (usually $1,000)
PPT 16-5
Bond Terminology
Par Value:
principal or face value (usually $1,000)
Coupon Rate:
stated interest rate
Maturity Date:
date when repayment of principal is due
Indenture:
legal document detailing the corporation’s obligations and Restrictive Covenants
Secured Debt:
where specific assets are pledged in the event of default
Debenture:
a L/T unsecured corporate bond

5. Figure 16-2 Priority of claims
PPT 16-6
Figure 16-2 Priority of claims
Senior
Junior
Preferred stock
Common stock
Unsecured debt
(debentures)
First claim on assets pledged
Second claim on assets pledged
Remaining assets are distributed below.
Lower priority
of claims
Subordinated debenture holders will not receive
payment unless designated senior debenture
holders are paid in full.
Secured debt
Subordinated

6. Methods of Retiring (Repaying) Bonds
PPT 16-7
Methods of Retiring (Repaying) Bonds
Principal at maturity:
lump-sum payment when bond is due
Serial payments:
bond is paid off in installments
Sinking fund:
corporation contributes regularly to
a trust fund used to buy back bonds
Conversion:
bond can be converted into shares of common stock at the option of the bondholder
Call feature:
corporation can redeem bonds early by paying a premium over par value

7. Reading Bond Price Quotations
PPT 16-9
Reading Bond Price Quotations
Maturity Date
(April 8, 2022)
Coupon
(interest rate %)
Company Name
Change
(Closing
price up
$1.11 from
previous day)
Price
(Last transaction
price = $138.50/ $100)
Yield
(Annual interest
Market price) 20 20

8. PPT 16-10
Table 16-2: Interest rates and bond prices (the bond pays 12 percent interest)

9. 3 Types of Bond Yields Coupon Rate (or Nominal Yield ):
PPT 16-11
3 Types of Bond Yields
Coupon Rate (or Nominal Yield ):
interest payment divided by par value
Current Yield:
interest payment divided by current price of the bond
Yield-to-Maturity (YTM):
interest rate that equates the future (expected) interest payments and payment at maturity to the current market price of the bond
affected by current market interest rates
If rates , YTM , bond price 
and bond rating
If rating high (low risk), YTM 

10. Figure 16-3 Long-term yields on corporate debt
PPT 16-12
Figure 16-3 Long-term yields on corporate debt

11. Bond Ratings Bond Ratings PPT 16-13 Medium Grade High (Investment Poor
Rating Service
Grade
Grade)
Speculative
Grade
Moody's
Aaa Aa
A Baa
Ba B
Caa to C
Standard & Poor's
AAA AA
A BBB
BB B
CCC to D
Dominion
AAA
BBB B C
Risk Factor
Low
High 14 14

12. Table 16-3 Outstanding debt issues, March 1, 2002
PPT 16-14
Table 16-3 Outstanding debt issues, March 1, 2002
Rating/Issuer Coupon Maturity Date Price Yield to Maturity
AAA
CARDS Trust Receivables Dec. 21/
Government of Canada Sept. 01/
Government of Canada June 01/ AA
BMO May 9/
BMO Dec. 31/
Nav Canada Dec 01/
Nav Canada June 01/ A
Bell Canada June 28/
Bell Canada April 02/
Loblaw June 02/
Loblaw Nov. O8/
BBB
Domtar Apr. 15/
Talisman Jan. 30/ BB
Rogers Cable June 01/ B
Air Canada Feb 02/
Saskatchewan Wheat Pool July 18/

13. Other Forms of Bond Financing
PPT 16-17
Other Forms of Bond Financing
Zero-Coupon Bond / Strip Bond:
does not pay interest
is issued at a deep discount from face value
Floating Rate Bond:
interest rate paid on the bond changes with market conditions
Real Return Bond
principal adjusted for inflation
Revenue Bond
security based upon cash flow
Eurobond:
bond issued in another country

14. Table 16-4 Examples of Eurobonds
PPT 16-18
Table 16-4 Examples of Eurobonds
Amount
Outstanding Currency
Rating Coupon Maturity ($ millions) Denomination*
Petro-Canada Baa % U.S.$
Procter & Gamble Co. Aa % C$
Sony Corporation Aa % Yen
Telecom Corporation Aa % N Z$
*C$ is Canadian dollar, and N Z $ is New Zealand dollar.
Source: Mergent Bond Report,July 2000
Source: Moody’s Bond Record, July

15. Advantages and Disadvantages of Debt
PPT 16-19
Advantages and Disadvantages of Debt
Advantages of Debt:
interest payments are tax deductible to a firm
wise use of debt may lower a firm’s weighted average cost of capital (WACC)
financial obligation is fixed
no reduction in control or equity of present shareholders
company may get a better return on equity from leverage

16. Advantages and Disadvantages of Debt
PPT 16-20
Advantages and Disadvantages of Debt
Disadvantages of Debt:
interest and principal must always be met when due, regardless of a firm’s financial position
agreements may restrict financial management in firm
poor use of debt may lower a firm’s stock price
expensive financing when interest rates are high

17. 2 Types of Leases Capital Lease (or Financing Lease):
PPT 16-21
2 Types of Leases
Capital Lease (or Financing Lease):
Lease payments are usually sufficient to fully cover the lessor’s cost of purchasing the assets and provide the lessor a return on investment
The lessee is usually responsible for the upkeep of the asset
Generally, lease cannot be cancelled
must be shown on a firm’s balance sheet
ex., oil drilling equipment and airplanes

18. 2 Types of Leases Operating Lease: Usually a shorter term lease
PPT 16-21
2 Types of Leases
Operating Lease:
Usually a shorter term lease
a conventional rental agreement
Often cancellable on short notice
Lessor is responsible for upkeep of asset
firm doesn’t expect to own the asset
is not shown on a firm’s balance sheet
ex., automobiles and office equipment

19. Capital Lease Criteria
A lease is considered a Capital Lease if it meets one of the following criteria:
The lease transfers ownership of the asset to the lessee at the end the lease term
Lessee has the option to purchase the asset at a price below the fair market value when the lease expires.
The lease term is 75% or more of the estimated economic life of the asset
The PV of the lease payments is at least 90% of the fair market value of the asset at the start of the lease

20. Advantages of Leasing A loan may be more expensive / refused
PPT 16-22
Advantages of Leasing
A loan may be more expensive / refused
There may be no down payment on a lease, but usually a down payment with a loan
A lease may have fewer restrictions than a loan
There is a fixed payment on a lease, but loan interest may vary with prime
Lease from a manufacturer may have attractive terms (ex: lower interest cost) or provide specialist expertise
Using a lease may restrict creditor claims in bankruptcy
Lease may be preferable for equipment with rapid obsolescence (ex: computers)
May have more tax advantages using a lease

21. Lease vs Borrow-Purchase Problem
A Firm is considering the purchase of an asset as opposed to leasing it.
The asset costs $5,000. To purchase it, the firm must get a loan from its bank. The loan amortization will be $1,319 for 5 years at 10%. Interest payments from yrs. 1 to 5 are: $500, $418, $328, $229, and $120. CCA rate is 20 %.
To lease the asset, the firm must pay $1,250 during the 1st and 2nd years, and $1,800 during the 3rd to 5th years. Note that lease payments are made at the beginning of each year.
Tax rate is 40%
Which option is less costly?

22. Table 16-7 Net present value of borrow-purchase
PPT 16-23
Table 16-7 Net present value of borrow-purchase

23. Table 16-8 Net present value of operating lease outflows
PPT 16-24
Table 16-8 Net present value of operating lease outflows

24. Summary and Conclusions
PPT 16-25
Summary and Conclusions
Debt financing by major corporations often involves the sale of secured bonds or unsecured bonds (debentures).
Corporate bonds may have sinking-fund, call, or conversion features causing retirement before maturity.
Bond prices and yields are inversely related and are based upon the level of interest rates and bond ratings
Long-term capital leases are an alternative form of long-term financing