978-0078025549 Chapter 9 Solution Manual Part 1

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Question 9-1 (LO 9-1)

Capital structure is the mixture of liabilities and stockholders’ equity a business uses. Companies in

the auto industry, like Ford, typically lean more toward liabilities for their financing, while companies in

Question 9-2 (LO 9-1)

One of the primary reasons a company chooses to borrow money rather than issue additional stock

A second reason relates to control. If a company issues additional shares to investors, control in the

Question 9-3 (LO 9-1)

Bond issue costs include underwriting services, legal, accounting, registration, and printing fees

Question 9-4 (LO 9-1)

A company that borrows by issuing bonds is effectively by-passing the bank and borrowing directly

from the investing public, usually at a lower interest rate than in a bank loan. However, issuing bonds

entails significant bond issue costs that often exceed 5% of the amount borrowed. For smaller loans, the

Question 9-5 (LO 9-2)

(a) Secured bonds are supported by assets pledged as collateral. Unsecured bonds, also referred to as

debentures, are not backed by a specific asset. (b) Term bonds require payment of the full principal

Answers to Review Questions (continued)

Question 9-6 (LO 9-2)

Convertible bonds allow the investor to convert each bond into a specified number of shares of

common stock. The investor benefits from the conversion feature if share prices rise above the fixed

conversion rate. For instance, assume a $1,000 bond is convertible into 40 shares of common stock, when

Chapter 9

Long-Term LiabilitiesREVIEW Questions

Question 9-7 (LO 9-3)

We calculate the issue price of a bond as the present value of the principal (the face amount on the

bond due at maturity) plus the present value of the periodic interest payments. It is not solely the present

Question 9-8 (LO 9-3)

(a) The face amount is the amount that will be repaid at maturity. The carrying value is the balance in

the bonds payable account at any point in time. For example a $100,000 bond that issues for $93,205 has

Question 9-9 (LO 9-3)

The bonds issue at a discount when the stated interest rate is less than the market interest rate. The

Question 9-10 (LO 9-3)

The bonds issue at a premium when the stated interest rate is more than the market interest rate. The

Question 9-11 (LO 9-3)

The cash payment every six months is $15,000 ($500,000 x .06 x 6/12). There

Question 9-12 (LO 9-3)

(a) $562,757

(b) $500,000

(Note: These answers are based on a calculator/excel. Answers using the present

Answers to Review Questions (continued)

Question 9-13 (LO 9-4)

If bonds issue at a discount, the carrying value of the bonds and interest expense will increase over

Question 9-14 (LO 9-4)

If bonds issue at a premium, the carrying value of the bonds and interest expense will decrease over

Question 9-15 (LO 9-4)

Cash paid is calculated as the face amount of the bonds times the stated interest rate. Interest expense

is the carrying value times the market rate. The difference between interest expense and the cash paid

The amortization schedule is similar when bonds are issued at a premium, except that the difference

Question 9-16 (LO 9-5)

If interest rates decrease, a company may choose to buy back high interest rate bonds and reissue

bonds at a lower interest rate. A company can help protect itself from decreases in interest rates by

Another incentive to repay debt early is to improve the company’s debt and profitability ratios.

Question 9-17 (LO 9-5)

A loss of $50,000 is recorded by the issuer retiring the bonds as follows:

Bonds Payable 280,000

Loss 50,000

Answers to Review Questions (continued)

Question 9-18 (LO 9-6)

Both interest expense and the carrying value of the note decrease over time. Interest expense

decreases with each installment payment. In each of the following periods, the amount that goes to

Question 9-19 (LO 9-6)

Operating leases are like rentals. Short-term car rentals and most apartment leases are operating

Question 9-20 (LO 9-7)

Additional debt increases risk. Failure to repay debt or the interest associated with the debt on a

timely basis may result in default and perhaps even bankruptcy. Other things being equal, the higher the

BRIEF Exercises

Brief Exercise 9-1 (LO 9-2)

1. Convertible bonds sell at a higher price and require a lower interest rate than bonds without a

2. Investors in convertible bonds benefit if the market price of the common stock goes above $50 per

share ($1,000/20 shares = $50 per share) assuming the current market price of the bond is $1,000. If

Brief Exercise 9-2 (LO 9-3)

If the market rate is 7%, the bonds will issue at $60,000 (face amount).

Calculator Input

Bond

Characteristics Key Amount

1. Face amount FV $60,000

2. Interest payment PMT $2,100 = $60,000 x 7% x ½ year

Calculator Output

Issue price PV $60,000

Brief Exercise 9-3 (LO 9-3)

If the market rate is 8%, the bonds will issue at $54,812 (a discount).

Calculator Input

Bond

Characteristics Key Amount

1. Face amount FV $60,000

2. Interest payment PMT $2,100 = $60,000 x 7% x ½ year

Calculator Output

Issue price PV $54,812

Brief Exercise 9-4 (LO 9-3)

If the market rate is 6%, the bonds will issue at $66,934 (a premium).

Calculator Input

Bond

Characteristics Key Amount

1. Face amount FV $60,000

2. Interest payment PMT $2,100 = $60,000 x 7% x ½ year

Calculator Output

Issue price PV $66,934

Brief Exercise 9-5 (LO 9-4)

January 1, 2015

Cash 70,000

June 30, 2015

Interest Expense 2,450

Brief Exercise 9-6 (LO 9-4)

January 1, 2015

Cash 63,948

June 30, 2015

Interest Expense ($63,948 x 8% x ½) 2,558

Brief Exercise 9-7 (LO 9-4)

January 1, 2015

Cash 76,860

June 30, 2015

Interest Expense ($76,860 x 6% x ½) 2,306

Bonds Payable (difference) 144

Brief Exercise 9-8 (LO 9-4)

January 1, 2015

Cash 70,000

December 31, 2015

Interest Expense 4,900

Brief Exercise 9-9 (LO 9-4)

January 1, 2015

Cash 64,008

December 31, 2015

Interest Expense ($64,008 x 8%) 5,121

Bonds Payable (difference) 221

Brief Exercise 9-10 (LO 9-4)

January 1, 2015

Cash 76,860

December 31, 2015

Interest Expense ($76,860 x 6%) 4,612

Bonds Payable (difference) 288

Brief Exercise 9-11 (LO 9-4)

$2,653 ($88,443 x 6% x ½).

Brief Exercise 9-12 (LO 9-4)

Interest expense for the year ended December 31, 2015 would be $2,765. Interest expense for the first six

months ended June 30, 2015 is $2,075 ($82,985 x 5% x ½). Interest expense for the next six months

Brief Exercise 9-13 (LO 9-4)

Cash 63,948

Interest Expense 2,558

Bonds Payable 108

3. Interest expense increases each period because the carrying value of the debt issued at a discount

increases over time.

Brief Exercise 9-14 (LO 9-4)

Cash 76,860

Interest Expense 2,306

Bonds Payable 144

3. Interest expense decreases each period because the carrying value of the debt issued at a premium

decreases over time.

Brief Exercise 9-15 (LO 9-5)

Bonds Payable 64,168

Loss 3,832

Brief Exercise 9-16 (LO 9-5)

Bonds Payable 76,567

Gain 4,567

Brief Exercise 9-17 (LO 9-6)

January 1, 2015

Equipment 30,000

January 31, 2015

Interest Expense ($30,000 x 5% x 1/12) 125.00

Notes Payable (difference) 441.14

Brief Exercise 9-18 (LO 9-7)

Total

Liabilities ÷

Stockholders’

Equity =

Debt to Equity Ratio

Net

Income ÷

Average Total Assets

Return on Assets Ratio

Net

Income

Average

Stockholders’

Equity

=Return on Equity Ratio

Net Income +

Interest + Taxes ÷

Interest

Times Interest Earned

Ratio

The return on equity is higher than the return on assets, because the return on equity divides by

average stockholders’ equity which is smaller than average total assets