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22) Gary’s Gadgets prepared the following preliminary balance sheet a few days before its
December 31 yearend:
Gary's Gadgets
Preliminary Balance Sheet
December 27, 2011
Cash $ 6,000 Accounts payable $ 2,500
Accounts receivable 3,000
Inventory 2,000 Common stock 1,000
______ Retained earnings 7,500
Total liabilities &
Total assets $11,000 shareholders' equity $11,000
a. Use the preliminary balance sheet to calculate the debt-to-equity ratio.
b. Gary thinks that investors will be more interested in his company if it has very few liabilities.
He plans to pay $2,000 of the accounts payable before December 31. What will the new debt-to-
equity ratio be after the payment has been made?
c. Is it ethical to make last-minute payments to improve the appearance of the balance sheet?
d. Is it true that investors prefer companies with very little debt? Explain positive financial
leverage.
23) Match each of the following items with the appropriate definition below.
a. zero-interest bonds
b. bond discount
c. bond premium
d. financial leverage
e. callable bonds
f. debt-to-equity ratio
g. bond interest payment
h. carrying value
i. convertible bonds
______ 1. occurs when a bond is sold for more than the face value of the bond
______ 2. occurs when a bond is sold for less than the face value of the bond
______ 3. the value of a bond, minus its unamortized discount or plus its unamortized premium
______ 4. the face value of a bond times the stated interest rate of the bond
______ 5. a bond that pays no interest during its life
______ 6. bonds that have a feature that allows the issuing company to buy back the bonds
before maturity
______ 7. bonds that can be converted into common stock at the option of the investor
______ 8. the concept of using borrowed funds to increase earnings
______ 9. a ratio that compares the value of the creditors’ claims with the value of the owners’
claims
Learning Objective 7-7
1) The risk associated with debt is risk to ________.
A) the borrowing company
B) the issuing company’s creditors
C) financial analysts following a company
D) positive financial leverage
2) The primary risk associated with long-term debt is the risk of ________.
A) raising money from investors
B) raising money from creditors
C) not being able to make the debt payments
D) positive financial leverage
3) Which of following is NOT a step that should be taken to minimize risk associated with long-
term debt? A company should ________.
A) conduct a thorough business analysis when a decision is made to borrow money
B) evaluate the characteristics of the various types of debt
C) make sure that there is a high probability of positive financial leverage
D) maximize its debt-to-equity ratio
4) The primary risk associated with long-term debt is the risk of not being able to make the debt
payments.
5) Risks associated with debt affect both a company and its creditors.
6) Off-balance-sheet financing is always illegal.
7) Companies should always maximize its debt-to-equity ratio.
8) The higher the debt-to-equity ratio the greater the positive financial leverage.
9) Ken’s Kandy prepared the following preliminary balance sheet a few days before its
December 31 yearend:
Ken's Kandy
Preliminary Balance Sheet
December 27, 2011
Cash $1,000 Accounts payable $4,000
Accounts receivable 2,000
Inventory 500 Common stock 3,000
Equipment 5,500 Retained earnings 2,000
Total liabilities &
Total assets $9,000 shareholders' equity $9,000
Ken is concerned about the size of the accounts payable in relation to the company’s cash and
other current assets. He asks the accountant to reclassify $3,000 of the accounts payable as long-
term notes payable before releasing the annual report on December 31.
a. What is the company’s current ratio now, based on the preliminary balance sheet?
The formula for calculating the current ratio is current assets / current liabilities.
b. What will the company’s current ratio be if $3,000 of the accounts payable are reclassified as
long-term notes payable?
c. Will reclassifying the accounts payable have any effect on the debt-to-equity ratio? Explain.
d. Is it ethical to reclassify current liabilities as long-term liabilities, as long as total liabilities are
correct?
10) Team instructions: Provide students with copies of real merchandising companies' annual
reports, or give students the Web addresses of real merchandising companies and ask them to
print out the annual reports.
Divide the class into teams of three or four people. All team members should work with the same
company’s annual report. Give the students time in class to answer the following questions for
their company. Each team should turn in only one copy of the answers for grading, along with a
copy of the annual report that they used. All team members will receive the same grade.
1.
What is the name of your company?
2.
Calculate the debt-to-equity ratio for the most recent year.
3.
Which financial statement(s) do you need…?
4.
Calculate the debt-to-equity ratio for the previous year.
5.
Has the company’s financial leverage increased?
6.
Which footnote … describes the company’s long-term debt?
7.
Has the company issued any bonds in years past?
8.
What interest rate is the company paying on its bonds?
9.
When do the bonds mature?
10.
Did the company make any payments on its long-term debt in
the most recent year shown?
11.
Which financial statement shows you this information?
12.
Has the company taken on any additional long-term debt in
the most recent year shown?
13.
Which financial statement shows you this information?
11) Team instructions: Provide students with copies of the financial statements for Team Shirts
for June and July. Divide the class into teams of three or four people. Give the students time in
class to answer the following questions. Each team should turn in only one copy of the answers
for grading. All team members will receive the same grade.
1.
Does Team Shirts have any estimated liabilities?
If yes, then name them.
2.
Calculate the debt-to-equity ratio for July.
$151,654 / ($5,000 + 75,856)
3.
Which financial statement(s) do you need to calculate this ratio?
4.
Calculate the debt-to-equity ratio for June.
$42,750 / ($5,000 + 22,072)
5.
Has the company’s financial leverage increased?
6.
What business event explains the change in the debt-to-equity ratio?
7.
Has the company issued any bonds?
8.
Did the company make any payments on its long-term debt in July?
9.
Which financial statement shows you this information?
10.
Has the company taken on any additional long-term debt in July?
11.
Which financial statement shows you this information?
1) Discounting means ________.
A) selling bonds for less than face value
B) calculating the present value of future cash flows
C) selling bonds for more than face value
D) selling bonds at par value
2) Buzz Corporation issued $50,000 worth of 10-year, 8% bonds for $48,359.66. The $48,359.66
is the ________.
A) face value
B) present value
C) future value
D) stated rate
3) On January 1, 2011, Alpha Company issued $1,000,000 of 5%, 20-year bonds to buy a new
computerized accounting system. The market rate of interest was 6%. The bonds pay interest
annually on December 31. On its balance sheet at December 31, 2011, Alpha will show bonds
payable of $1,000,000 ________.
A) minus the unamortized discount
B) plus the unamortized discount
C) minus the unamortized premium
D) plus the unamortized premium
4) Z Biz sold a 5-year, $1,000, zero-interest bond for $497.18 when the market rate of interest
was 15%. The present value of the principal is ________.
A) $74.58
B) $5,000
C) $497.18
D) $1,000.00
5) Stanton Corporation sold a 10-year, $1,000, zero-interest bond when the market rate of
interest was 7%. The present value of the principal is ________.
A) $508.35
B) $700.00
C) $1,000.00
D) $1070.00
6) Z Best, Inc. sold a 5-year, $1,000, zero-interest bond for $497.18 when the market rate of
interest was 15%. The total cost of borrowing $497.18 is ________.
A) $750.00
B) $502.82
C) $497.18
D) $1,000.00
7) On January 1, 2011, Alpha Company issued $1,000,000 of 5%, 20-year bonds to buy a new
computerized accounting system. The market rate of interest was 6%. The bonds pay interest
annually on December 31. To calculate the amount of cash that Alpha received, you must find
________.
A) only the present value of $1,000,000
B) only the present value of an annuity of $60,000
C) both the present value of $1,000,000 and the present value of an annuity of $50,000
D) both the present value of $1,000,000 and the present value of an annuity of $60,000
8) On January 1, 2011, Alpha Company issued $1,000,000 of 5%, 20-year bonds to buy a new
computerized accounting system. The market rate of interest was 6%. The bonds pay interest
annually on December 31. To calculate the amount of cash that Alpha received, you must use a
discount rate of ________.
A) 20%
B) 6%
C) 5%
D) The answer cannot be determined from the information given.
9) A series of equal payments in which the payment is made at the end of each period is a(n)
________.
A) annuity due
B) ordinary annuity
C) prepaid annuity
D) beginning annuity
10) Ima Baroque wants to borrow $100,000 in order to expand Bank, Rupp & Baroque, Inc. If
she repays the money in equal monthly installments over two years, she can get an interest rate
of 12%. What interest rate and periods should you use to calculate the amount of each
installment payment?
A) 12% for twenty four periods
B) 1% for twenty four periods
C) 12% for two periods
D) 24% for one period
11) Tom wants to borrow $15,000 in order to expand Tom’s Wear. If he repays the money in
forty equal monthly installments, he can get an interest rate of 6%. What would be the amount of
each installment payment?
A) $375.00
B) $397.50
C) $996.93
D) $414.68
12) Tom wants to borrow $15,000 in order to expand Tom’s Wear. If he repays the money in
forty equal monthly installments, he can get an interest rate of 6%. How much interest will he
pay over the life of the loan?
A) $1,587.20
B) $900.00
C) $3,000
D) $414.68
13) On January 1, 2011, Alpha Enterprise signed a $100,000, 6%, 20-year mortgage note to buy
a new warehouse. The mortgage will be repaid in a series of twenty equal annual installment
payments. Calculate the amount of each payment. Round your answer to the nearest dollar.
A) $8,718
B) $5,000
C) $11,000
D) $6,000
14) On January 1, 2011, Zenith, Inc. signed a $200,000, 5%, 20-year mortgage note to buy a new
office building. The mortgage will be repaid in a series of twenty equal annual installment
payments. Calculate the amount of each payment. Round your answer to the nearest dollar.
A) $10,000
B) $16,049
C) $10,500
D) $20,000
15) On January 1, 2011, Nadir Company issued $1,000,000 of 6%, 20-year bonds when the
market rate of interest was 5%. The bonds pay interest annually on December 31. To calculate
the amount of cash that Nadir received, you must find ________.
A) only the present value of $1,000,000
B) only the present value of an annuity of $60,000
C) both the present value of $1,000,000 and the present value of an annuity of $50,000
D) both the present value of $1,000,000 and the present value of an annuity of $60,000
16) On January 1, 2011, Bondz, Inc. issued $1,000,000 of 5%, 10-year bonds when the market
rate of interest was 6%. The bonds pay interest annually on December 31. To calculate the
amount of cash that Bondz received, you must use a discount rate of ________.
A) 20%
B) 6%
C) 5%
D) The answer cannot be determined from the information given.
17) On January 1, 2011, Bondz, Inc. issued $1,000,000 of 10%, 10-year bonds when the market
rate of interest was 12%. The bonds pay interest QUARTERLY. To calculate the amount of cash
that Bondz received, you must use a discount rate of ________.
A) 10%
B) 12%
C) 4%
D) 3%
18) On January 1, 2011, Alpha Company issued $1,000,000 of 5%, 20-year bonds to buy a new
computerized accounting system. The market rate of interest was 6%. The bonds pay interest
annually on December 31. These bonds sold at a _____ because the market rate of interest is
_____ than the stated interest rate.
A) discount; higher
B) premium; higher
C) discount; lower
D) premium; lower
19) On January 1, 2011, Alpha Company issued $1,000,000 of 5%, 20-year bonds to buy a new
computerized accounting system. The market rate of interest was 6%. The bonds pay interest
annually on December 31. How much cash did Alpha receive when the bonds were sold?
A) $1,000,000
B) $1,124,622.60
C) $885,296
D) $950,386
20) On January 1, 2011, Alpha Company issued $1,000,000 of 5%, 20-year bonds to buy a new
computerized accounting system. The market rate of interest was 6%. The bonds pay interest
annually on December 31. How much cash will bondholders receive when the bonds mature?
A) $1,000,000
B) $1,124,622.60
C) $885,296
D) $950,386
21) On January 1, 2011, Alpha Company issued $1,000,000 of 5%, 20-year bonds to buy a new
computerized accounting system. The market rate of interest was 6%. The bonds pay interest
annually on December 31. How much cash will bondholders receive on December 31, 2011, the
first interest payment date?
A) $60,000
B) $50,000
C) $30,000
D) $25,000
