Foundations of Financial Management, 17e (Block)
Chapter 16 Long-Term Debt and Lease Financing
1) Although the times interest earned ratio of many corporations went down tremendously during
the 2007-2008 financial crisis, the ratio has been increasing steadily mainly because companies
took advantage of the recent low interest rates.
2) One of several reasons that companies might choose to issue bonds is to shift their capital
structure from more equity ownership to more debt borrowing.
3) Homebuilding companies, like D.R. Horton Inc., realized significant losses in 2008-2009, but
have realized gains since then.
4) Par value and face value on a bond generally are the same.
5) A bond indenture is a bond with no specific collateral securing it.
6) When a company defaults on a secured debt, it is rare for the secured asset to be sold and the
proceeds distributed to the debtor.
7) Debentures are commonly issued by small companies.
8) When a company is obligated contractually to pay interest on debt, it must pay the interest
even if it shows no profit for the year, or else it may go bankrupt.
9) Bonds may be recalled only if there is a specific call provision in the bond.
10) The fact that interest payments on debt are fixed is both an advantage and a drawback to both
parties involved.
11) An after-acquired property clause means that any new property acquired is placed under the
original mortgage claim.
12) If a corporation offers greater protection to a given class of bondholders, it must raise the
interest rate on its bonds to make them more attractive to investors.
13) Because of the legal problems associated with specific asset claims in a secured bond
offering, the trend is for companies to issue more debentures.
14) During a default situation, a bondholder is better off with a secured loan because debenture
bonds don’t give the bondholder any protection.
15) The call feature is usually advantageous to the bondholder.
16) The call premium tends to increase with the passage of time.
17) Under a sinking fund provision, money is set aside every year until the bond matures, and the
money is used to purchase bonds from willing sellers.
18) A bondholder is one that buys the bond, while the bond issuer is the one that sells the bond.
19) In the U.S., bond issuers can be either corporations or the government.
20) Long-term bond prices are more volatile than short-term bond prices, given an equal
percentage change in the interest rate.
21) The maturity date is the final date on which repayment of the bond interest is due.
22) The coupon rate is the actual interest rate on the bond and is usually payable in semiannual
installments.
23) The value of bonds will move in the opposite direction from the market interest rates.
24) If an investor expect interest rates to go up, the investor should buy a long-term bond now.
25) If an investor expect interest rates to go up, the investor should sell a long-term bond now.
26) The “yield to maturity” is the internal rate of return on a bond.
27) The coupon rate is the actual interest that the seller pays, which may not equal the amount
that the seller incurs for an expense.
28) During economic upswings, spreads between bonds of different ratings tend to widen.
29) When interest rates rise, bond refunding becomes quite popular.
30) As interest rates decline, bond refunding should become more common.
31) Refunding a bond occurs when the company sells more bonds of the same series with
maturity and a coupon equal to the bonds sold earlier.
32) A bond can only be easily refunded if it has a call feature.
33) The costs of bond refunding are the call premium and the underwriting costs on the old and
new bond issue.
34) The payment of a call premium may generally be taken as an immediate tax write-off.
35) The costs of bond refunding are the call premium and the underwriting cost on the new bond
issue.
36) The weighted average cost of capital is generally used as the discount rate in a bond-
refunding decision.
37) Zero-coupon bonds are sold at a deep discount primarily because investors are not interested
in owning them.
38) Zero-coupon bonds are more risky then other bonds because there is no interest payments
involved during the life of the bond.
39) The prices of zero-coupon bonds tend to react violently to large swings in interest rates.
40) Zero-coupon bonds are sold at face value because no interest is paid.
41) The difference between the initial bond price and the maturity value is amortized for tax
purposes over the life of a zero-coupon bond.
42) An advantage of the zero coupon bond is that there is no coupon, so the yield to maturity is
locked in for the life of the bond.
43) The disadvantage of a zero-coupon bond to an investor is that the annual increase in the bond
is taxable as ordinary income and no annual cash payments are received to pay for the tax
charges.
44) The primary advantage of investing in floating rate bonds is that the bonds will maintain a
more stable market value within a reasonable limit.
45) The initial floating rate bond price is inversely related to changes in interest rates.
46) A floating rate bond has a reasonably stable price, but actual interest payments received
change often over the life of the bond.
47) A Eurobond is a bond payable in the borrower’s currency but sold outside the borrower’s
country.
48) In an inflationary economy, debt is adjusted for inflation and must be paid back with “more
expensive dollars.”
49) A capital (or “financing”) lease usually calls for an annual expense deduction equal to the
lease payment.
50) Lease obligations, whether capital or operating, currently appear only in the footnotes of U.S.
corporate financial statements.
51) Under a sinking fund arrangement, semiannual or annual contributions are made by the
corporation into a fund administered by a trustee for purposes of debt retirement.
52) Bonds with serial payment provisions are paid off in installments over the life of the issue.
53) The lessee is the one making the rental payments, while the lessor is the one receiving the
rental payments.
54) In an operating lease situation, the lessee shows the asset and the debt on its financial
statements.
55) Leasing land through an operating lease provides a tax advantage to the lessee in that lease
payments are tax-deductible, while there is no deduction for the landowner.
56) The essence of the treatment of long-term, non-cancelable capital leases is the same as if the
company had borrowed the money and bought the asset.
57) The inclusion of leases on the balance sheet as an asset and liability has lowered firm’s debt–
to-equity ratio.
58) An operating lease is generally a long-term, non-cancelable obligation.
59) A capital lease has many of the characteristics of a long-term debt obligation.
60) Bond refunding is generally advantageous to the investor because the investor gets a higher
future interest rate.
61) Many companies try to maintain investment grade status due to the significant yield
differential when rated with a junk-bond status.
62) Bond ratings start with Aaa and end with C or Aaa1 and end with C3.
63) A low bond rating during a bad economic time means that the company will have to issue
new bonds at a higher rate.
64) Yield spreads between investment grade and junk bond ratings are usually greater during
economic boom periods.
65) A challenge for multinational corporations is trying to get the right financing for certain
operating activity expectations.