Chapter 10 Reporting and Analyzing Long-Term Liabilities Answer
Key
True / False Questions
1.
The legal contract between the issuing corporation and the bondholders is called the bond
indenture.
2.
One of the similarities of bond and equity financing is that both interest and equity
payments are tax deductible.
3.
A disadvantage of bond financing over equity financing is the burden on the cash flows of
the company.
4.
Term bonds are scheduled for maturity on one specified date, whereas serial bonds
mature at more than one date.
5.
Debentures always have specific assets of the issuing company pledged as collateral.
6.
Callable bonds have an option exercisable by the issuer to retire them at a stated dollar
amount prior to maturity.
7.
Callable bonds can be exchanged for a fixed number of shares of the issuing corporation’s
common stock.
8.
A particular feature of callable bonds is that they 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.
9.
Issuers of coupon bonds are not allowed to deduct the interest expense on their tax
returns.
10.
A bond’s par value is not necessarily the same as its market value.
11.
An installment note is an obligation of the issuing company that requires a series of
periodic payments to the lender.
12.
Payments on an installment note normally include the accrued interest expense plus a
portion of the amount borrowed.
13.
Bonds and long-term notes are similar in that they are typically transacted with multiple
lenders.
14.
The carrying value of a long-term note is computed as the present value of all remaining
payments, discounted using the market rate at issuance.
15.
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 if the borrower fails to make the
required payments.
16.
Mortgage bonds are backed only by the good faith and credit of the issuing company.
17.
A basic present value concept is that cash paid or received in the future has less value
now than the same amount of cash today.
18.
A basic present value concept is that cash paid or received in the future has more value
now than the same amount of cash received today.
19.
Compounded means that interest during a second period is based on the total amount
borrowed plus the interest accrued in the first period.
20.
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.
21.
An annuity is a series of equal payments at equal time intervals.
22.
The present value of an annuity can be best or quickly computed as the sum of the
individual future values for each payment.
23.
The factor for the present value of an annuity 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.
24.
The factor for the present value of an annuity 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.
25.
A lease is a contractual agreement between a lessor and a lessee that grants the lessee
the right to use the asset for a period of time in return for cash payment(s) to the lessor.
26.
Operating leases are long-term or noncancelable leases in which the lessor transfers
substantially all the risks and rewards of ownership to the lessee.
27.
An advantage of lease financing is the lack of an immediate large cash payment for the
leased asset.
28.
A disadvantage of an operating lease is the inability to deduct rental payments in
computing taxable income.
29.
A pension plan is a contractual agreement between an employer and its employees to
provide benefits to employees after they retire.
30.
A bond is an issuer’s written promise to pay an amount identified as the par value of the
bond with interest.
31.
An advantage of bond financing is that issuing bonds does not affect owner control.
32.
Interest payments on bonds are determined by multiplying the par value of the bond by the
stated contract rate.
33.
The contract rate of interest is the rate that borrowers are willing to pay and lenders are
willing to accept for a particular bond and its risk level.
34.
Return on equity increases when the expected rate of return from new assets is higher
than the rate of interest expense on the debt financing.
35.
The use of debt financing ensures an increase in return on equity.
36.
Bond interest paid by a corporation is an expense, whereas dividends paid are not an
expense of the corporation.
37.
Collateral from unsecured loans may be sold to offset the loan obligation if the loan is in
default.
38.
A company’s ability to issue unsecured debt depends on its credit standing.
39.
A lessee has substantially all of the benefits and risks of ownership in an operating lease.
40.
A company with a low level of liabilities in relation to stockholders’ equity is likely to have
a very high debt-to-equity ratio.
41.
The debt-to–equity ratio is calculated by dividing total stockholders’ equity by total
liabilities.
42.
The debt-to–equity ratio enables financial statement users to assess the risk of a
company’s financing structure.
43.
A company has assets of $350,000 and total liabilities of $200,000. Its debt–to-equity ratio
is 0.6.
44.
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.
45.
The contract rate on previously issued bonds changes as the market rate of interest
changes.
46.
The market rate for bonds is generally higher when the time period to maturity is longer
due to the risk of adverse events occurring over a longer time period.
47.
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.
48.
When the contract rate on a bond issue is less than the market rate, the bonds will
generally sell at a discount.
49.
When the contract rate is above the market rate, a bond sells at a discount.
50.
A discount on bonds payable occurs when a company issues bonds with an issue price
less than par value.
51.
The carrying (book) value of a bond at the time when it is issued is always equal to its par
value.