Deck 14: Long-Term Liabilities

Question 1

Callable bonds reduce the bondholder's risk by requiring the issuer to create a sinking fund of assets set aside at specified amounts and dates to repay the bonds at maturity.

Answer 1

False

Question 2

Callable bonds can be exchanged for a fixed number of shares of the issuing corporation's ordinary shares.

Answer 2

False

Question 3

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

Answer 3

True

Question 4

The present value of an annuity can be best or easier computed as the sum of the individual future values for each payment.

Question 5

Mortgage bonds are backed only by the good faith and credit of the issuing company.

Question 6

Bonds and long-term notes are similar in that they are typically transacted with multiple lenders.

Question 7

Owners of coupon bonds are not required to pay tax on the interest earned.

Question 8

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

Question 9

A company invests $10,000 at 7% compounded annually. At the end of the second year, the company should have $11,400 in the fund.

Question 10

Callable bonds have an option exercisable by the issuer to retire them at a stated dollar amount prior to maturity.

Question 11

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

Question 12

A basic present value concept is that cash paid or received in the future is worth more than the same amount of cash received today.

Question 13

Mortgage contracts grant the lender the right to be paid from the cash proceeds of the sale of a borrower's assets identified in the mortgage.

Question 14

Debentures always have specific assets of the issuing company pledged as collateral.

Question 15

The legal contract between the issuing corporation and the bondholders is called the bond indenture.

Question 16

A basic present value concept is that cash paid or received in the future is worth less than the same amount of cash today.

Question 17

Term bonds are scheduled for maturity on one specified date, whereas serial bonds mature at more than one date.

Question 18

An installment note is an obligation of the issuing company that requires a series of periodic payments to the lender.

Question 19

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

Question 20

The carrying amount of a long-term note is computed as the present value of all remaining future payments, discounted using the market rate at the time of issuance.

Question 21

A company with a low level of liabilities in relation to shareholders' equity is likely to have a very high debt-to-equity ratio.

Question 22

The debt-to-equity ratio enables financial statement users to assess the risk of a company's financing structure.

Question 23

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.

Question 24

A bond is a written promise to pay an amount identified as the par value of the bond along with interest.

Question 25

Bond interest paid by a corporation is an expense, whereas dividends paid are not an expense of the corporation.

Question 26

The use of debt financing insures an increase in return on equity.

Question 27

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

Question 28

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

Question 29

Return on equity increases when the expected rate of return from the acquired assets is higher than the interest rate on the debt issued to finance the acquired assets.

Question 30

A company has assets of $350,000 and total liabilities of $200,000. Its debt-to-equity ratio is 0.6.
If total assets and total liabilities are $350,000 and $200,000, respectively, shareholders' equity must be $150,000. Thus, the debt-to-equity ratio is $200,000/$150,000 or 1.3.

Question 31

A company's ability to issue unsecured debt depends on its credit standing.

Question 32

An advantage of bond financing is that issuing bonds does not affect owner control.

Question 33

The contract rate on previously issued bonds changes as the market rate of interest changes.

Question 34

Long-term bonds have relatively higher interest rates because they carry higher risk due to the longer time period.

Question 35

When the contract rate on a bond issue is less than the market rate, the bonds will generally sell at a discount.

Question 36

The present value of an annuity factor 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.

Question 37

When the contract rate is above the market rate, a bond sells at a discount.

Question 38

Collateral from unsecured loans may be sold to offset the loan obligation if the loan is in default.

Question 39

Interest payments on bonds are determined by multiplying the par value of the bond by the stated contract rate.

Question 40

A 10-year bond issue with a $100,000 par value, 8% annual contract rate, with interest payable semiannually means that the issuer must repay $100,000 at the end of 10 years and make 20 semiannual interest payments of $4,000 each.

Question 41

Bonds that have interest coupons attached to their certificates, which the bondholders detach during each interest period and present to a bank for collection, are called:

A) Coupon bonds.
B) Callable bonds.
C) Serial bonds.
D) Convertible bonds.
E) Registered bonds.

Question 42

The equal total payments pattern for installment notes consists of changing amounts of interest but constant amounts of principal over the life of the note.

Question 43

When convertible bonds are converted to a company's shares, the carrying amount of the bonds is transferred to equity accounts and no gain or loss is recorded.

Question 44

Sinking fund bonds:

A) Require the issuer to set aside assets to retire the bonds at maturity.
B) Require equal payments of both principal and interest over the life of the bond issue.
C) Decline in value over time.
D) Are registered bonds.
E) Are bearer bonds.

Question 45

Bonds that have an option exercisable by the issuer to retire them at a stated dollar amount prior to maturity are known as:

A) Convertible bonds.
B) Sinking fund bonds.
C) Callable bonds.
D) Serial bonds.
E) Junk bonds.

Question 46

Two common ways of retiring bonds before maturity are to (1) exercise a call option or (2) purchase them on the open market.

Question 47

Premium on Bonds Payable is an adjunct or accretion liability account.

Question 48

A premium on bonds occurs when bonds carry a contract rate greater than the market rate at issuance and the premium reduces the interest expense of the bond over its life.

Question 49

Secured bonds:

A) Are called debentures.
B) Have specific assets of the issuing company pledged as collateral.
C) Are backed by the issuer's bank.
D) Are subordinated to those of other unsecured liabilities.
E) Are the same as sinking fund bonds.

Question 50

On January 1, a company issued a $500,000, 10%, 8-year bond payable, and received proceeds of $487,000. Interest is payable each June 30 and December 31. The total interest expense on the bond over its eight-year life is $400,000.

Question 51

A discount on bonds payable occurs when a company issues bonds with an issue price less than par value.

Question 52

A bond traded at 102½ means that:

A) The bond pays 2.5% interest.
B) The bond traded at $1,025 per $1,000 bond.
C) The market rate of interest is 2.5%.
D) The bonds were retired at $1,025 each.
E) The market rate of interest is 2 ½ % above the contract rate.

Question 53

Bonds owned by investors whose names and addresses are recorded by the issuing company, and for which interest payments are made with checks or cash transfers to the bondholders, are called:

A) Callable bonds.
B) Serial bonds.
C) Registered bonds.
D) Coupon bonds.
E) Bearer bonds.

Question 54

Payments on installment notes normally include accrued interest plus a portion of the principal amount borrowed.

Question 55

The issue price of bonds is found by computing the future value of the bond's cash payments, discounted at the market rate of interest.

Question 56

The market value or issue price of a bond is equal to the present value of all future cash payments provided by the bond.

Question 57

The carrying amount (book value) of a bond payable is the par value of the bonds plus the discount.

Question 58

The effective interest method yields increasing amounts of bond interest expense and decreasing amounts of premium amortization over the bond's life for bonds issued at a premium.

Question 59

The contract between the bond issuer and the bondholders, which identifies the rights and obligations of the parties, is called a(n):

A) Debenture.
B) Bond indenture.
C) Mortgage.
D) Installment note.
E) Mortgage contract.

Question 60

The carrying amount (book value) of a bond at the time when it is issued is always equal to its par value.

Question 61

Which of the following statements is ?

A) Interest on bonds is tax deductible.
B) Interest on bonds is not tax deductible.
C) Dividends to shareholders are tax deductible.
D) Bonds do not have to be repaid.
E) Bonds always increase return on equity.

Question 62

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:

A) $10,489.88.
B) $11,004.88.
C) $50,000.00.
D) $52,450.00.
E) $238,325.00.

Question 63

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?

A) Issuing the bonds would cause the firm's debt-to-equity ratio to improve from 1.0 to 1.3.
B) Issuing the bonds would cause the firm's debt-to-equity ratio to worsen from 1.0 to 1.3.
C) Issuing the bonds would cause the firm's debt-to-equity ratio to remain unchanged.
D) Issuing the bonds would cause the firm's debt-to-equity ratio to improve from .5 to .8.
E) Issuing the bonds would cause the firm's debt-to-equity ratio to worsen from .5 to .8.

Question 64

An advantage of bond financing is:

A) Bonds do not affect owners' control.
B) Interest on bonds is tax deductible.
C) Bonds can increase return on equity.
D) It allows firms to trade on the equity.
E) All of these.

Question 65

The carrying amount of a long-term note payable:

A) Is computed as the future value of all remaining future payments, using the market rate of interest.
B) Is the face value of the long-term note less the total of all future interest payments.
C) Is computed as the present value of all remaining future payments, discounted using the market rate of interest at the time of issuance.
D) Is computed as the present value of all remaining interest payments, discounted using the note's rate of interest.
E) Decreases each time period the discount on the note is amortized.

Question 66

Which of the following accurately describes a debenture?

A) A legal contract between the bond issuer and the bondholders.
B) A type of bond issued in the names and addresses of the bondholders.
C) A type of bond which requires the bond issuer to create a sinking fund of assets set aside at specified amounts and dates to repay the bonds.
D) A type of bond which is not collateralized but backed only by the issuer's general credit standing.
E) A type of bond that can be exchanged for a fixed number of shares of the issuing corporation's ordinary shares.

Question 67

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:

A) Registered bonds.
B) Bearer bonds.
C) Callable bonds.
D) Sinking fund bonds.
E) Serial bonds.

Question 68

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

A) Ownership rights in the issuing company.
B) The right to receive $10 per year until maturity.
C) The right to receive $1,000 at maturity.
D) The right to receive $10,000 at maturity.
E) The right to receive dividends of $1,000 per year.

Question 69

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

A) Safe deposit boxes.
B) Mortgages.
C) Equity.
D) The IASB.
E) Debentures.

Question 70

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?

A) Prepaying the debt would cause the firm's debt-to-equity ratio to improve from .62 to .50.
B) Prepaying the debt would cause the firm's debt-to-equity ratio to improve from .62 to .57.
C) Prepaying the debt would cause the firm's debt-to-equity ratio to worsen from .62 to .50.
D) Prepaying the debt would cause the firm's debt-to-equity ratio to worsen from .62 to .57.
E) Prepaying the debt would cause the firm's debt-to-equity ratio to remain unchanged.

Question 71

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

A) the amount of cash originally received in exchange for the bonds.
B) the par value that the issuer pays the holder.
C) the amount of discount or premium.
D) the amount of cash originally received in exchange for the bonds plus any unamortized discount or less any premium.
E) $0.

Question 72

The debt-to-equity ratio:

A) Is calculated by dividing carrying amount of secured liabilities by carrying amount of pledged assets.
B) Is a means of assessing the risk of a company's financing structure.
C) Is not relevant to secured creditors.
D) Can always be calculated from information provided in a company's income statement.
E) Must be calculated from the fair market values of assets and liabilities.

Question 73

Collateral agreements for a note or bond can:

A) Lower the risk in comparison with unsecured debt.
B) Increase the risk in comparison with unsecured debt.
C) Have no effect on risk.
D) Reduce the issuer's assets.
E) Increase total cost for the borrower.

Question 74

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:

A) $10,000.
B) $12,400.
C) $7,938.
D) $9,200.
E) $7,600.

Question 75

A disadvantage of bonds is:

A) Bonds require payment of periodic interest.
B) Bonds require payment of par value at maturity.
C) Bonds can decrease return on equity.
D) Bond payments can be burdensome when income and cash flow are low.
E) All of these.

Question 76

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:

A) $9,000.
B) $5,033.
C) $63,000.
D) $57,330.
E) $45,297.

Question 77

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

A) Debentures.
B) Discounted notes.
C) Installment notes.
D) Indentures.
E) Investment notes.

Question 78

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

A) Equity ratio.
B) Return on total assets ratio.
C) Pledged assets to secured liabilities ratio.
D) Debt-to-equity ratio.
E) Times secured liabilities earned ratio.

Question 79

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

A) The bondholders.
B) The bond issuer.
C) The bond indenture.
D) The bond trustee.
E) The bond underwriter.

Question 80

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:

A) $75,137.13.
B) $94,013.13.
C) $300,000.00.
D) $375,137.13.
E) $197,810.00.