Question 1

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

Accepted Answer

Bond interest paid is considered an expense on a corporation's income statement and is tax-deductible. Dividends, on the other hand, are not tax-deductible and are typically not considered an expense since they are paid out of the corporation's after-tax earnings. Instead, dividends are classified as a distribution of profits to shareholders.

Question 2

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.

Accepted Answer

A 10-year bond issue with a $100,000 par value and an 8% annual contract rate, with interest payable semiannually, would require the issuer to make 20 semiannual interest payments of $4,000 each in addition to the repayment of the $100,000 principal at maturity.

Question 3

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 the time period.

Accepted Answer

The longer the time period to maturity, the more uncertainty there is about future economic and political conditions, which increases the risk for investors. Therefore, to compensate for this risk, the market rate for longer-term bonds is generally higher than the rate for shorter-term bonds.

Question 4

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

Accepted Answer

The debt-to-equity ratio is calculated by dividing total liabilities by total stockholders' equity, not the other way around.

Question 5

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

Accepted Answer

The debt-to-equity ratio provides insight into how much debt a company has relative to equity, which can be an indicator of financial risk.

Question 6

A company has assets of $350,000 and total liabilities of $200,000. Its debt-to-equity ratio is 0.6.

Accepted Answer

The debt-to-equity ratio is calculated as total liabilities divided by shareholders' equity. Shareholders' equity is assets minus liabilities, which is $150,000 ($350,000 - $200,000). The debt-to-equity ratio is $200,000 / $150,000 = 1.33, not 0.6.

Question 7

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.

Accepted Answer

Return on equity is calculated by dividing net income by average equity. When an acquisition is made using debt financing, the cost of that debt (interest rate) will affect the return on equity. If the expected return from the acquired assets is higher than the interest rate on the debt, then the return on equity will increase. This is because the return on equity is calculated after deducting the interest expense on the debt.

Question 8

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

Accepted Answer

Debt financing can increase return on equity if the return on investment exceeds the cost of debt, but it also increases financial risk and can decrease return on equity if the cost of debt is higher.

Question 9

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

Accepted Answer

Unsecured loans do not have collateral, so there is no asset to sell to offset the loan obligation if the loan is in default.

Question 10

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

Accepted Answer

When the contract rate on a bond issue is less than the market rate, the bonds sell at a discount because investors are not willing to pay the full face value of the bond when they can earn a higher interest rate elsewhere. This creates a lower market price for the bond, resulting in it being sold at a discount.

Question 11

On January 1, a company issued a $500,000, 10%, 8-year bond payable, and received proceeds of
$473,845. Interest is payable each June 30 and December 31. The total interest expense on the bond over its eight-year life is $400,000.

Accepted Answer

The total interest expense is the sum of the cash interest payments and the discount amortization. The cash interest payments over 8 years are $400,000, but the discount of $26,155 ($500,000 - $473,845) also needs to be amortized, increasing the total interest expense.

Question 12

The carrying (book) value of a bond payable is the par value of the bonds plus any discount or minus any premium.

Accepted Answer

The carrying (book) value of a bond payable is the par value of the bonds minus any discount or plus any premium.

Question 13

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

Accepted Answer

A low level of liabilities in relation to stockholders' equity would result in a low debt-to-equity ratio, not a high one.

Question 14

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

Accepted Answer

The answer of The carrying (book) value of a bond...

Question 15

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

Accepted Answer

The contract rate, or coupon rate, on previously issued bonds remains fixed and does not change with fluctuations in the market rate of interest.

Question 16

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

Accepted Answer

A discount occurs when the selling price of the bond is less than par value, resulting in a lower effective interest rate for investors.

Question 17

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.

Accepted Answer

The statement is false. An increase in the debt-to-equity ratio means that the company has taken on more debt relative to equity, which increases the risk of default for the company. Therefore, the degree of risk in the firm's financing structure increased during Year 2.

Question 18

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

Accepted Answer

A company's credit standing is a major determinant of its ability to issue unsecured debt. If a company has a strong credit rating, it is more likely to be able to issue unsecured debt at favorable terms. Conversely, if a company's credit rating is weak, it may have difficulty accessing unsecured debt or may have to pay higher interest rates in order to do so.

Question 19

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

Accepted Answer

When the contract rate is above the market rate, a bond sells at a premium, not at a discount. Conversely, when the contract rate is below the market rate, a bond sells at a discount.

Question 20

A lessee has substantially all of the benefits and risks of ownership in an operating lease.

Accepted Answer

In an operating lease, the lessor retains substantially all the benefits and risks of ownership, not the lessee.

Quiz 14: Long-Term Liabilities