1. Financing Part I: Debt Chapter 14 in Spiceland See example excel files examplesexamples File names: Bonds and Leases

2. 2 Topics: Liabilities Notes Bonds Leases Current portion of non-current liabilities Non-current liabilities expected to be refinanced

3. 3 Non Current Liabilities: Notes ( longer than one year) Mortgage notes Car loan Bonds

4. 4 Bonds: Types Terms Issuance Calculation of price Rules Interest determination Retirement

5. 5 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

6. 6 Bonds (Terms): Indenture document – bond covenant Underwriters Face value - Maturity value Coupon rate Discount rate - yield rate – effective rate Issue price Premium - discount

7. 7 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 price 6. Difference between maturity value and issue price = Premium or (discount)

8. 8 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

9. 9 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

10. 10 Amortization of Premium Carrying value (CV) Interest rate Interest expense Interest paid Reduction in CV 113,591.044.5445000(456) 113,134.044.5255000(475) 112,660.044.5065000(513) 100,962.044,0385000(962) 100,000

11. 11 Amortization of Discount Carrying value (CV) Interest rate Interest expense Interest paid Reduction in CV 88,530.065,3125000312 88,841.065,3305000330 89,172.065,3505000350 99,057.065,9435000943 100,000

12. 12 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

13. 13 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

14. 14 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

15. 15 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

16. 16 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

17. 17 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