Chapter 8 – Financing a Business with

Debt

Bonds

A contract or written agreement that allows a company to borrow a specific amount of money

at specified terms:

o Interest

o Principal

o Repayment date(s)

Can be exchanged on the open market

Unsecured bonds debentures

Serial bonds matures periodically over time

Term bonds mature all at the same time

Key Terminology

Face value

o refers to the actual principle amount of the bond, i.e. amount to be repaid@ maturity

“Stated Rate” or “Coupon Rate” or “Contract Rate” or “Face Rate”

o Rate of interest paid on the bond to the bondholders (i.e. sets the cash payment)

o PYNT = Face Value x Stated Rate

Market Rate

o Rate demanded by investors to lend money to the company (given similar risks, terms

etc.)

o Sets the effective rate or discount rate used to determine the Net Present Value of

future payments rec’cl (paid) from the bond

Price of the Bonds

o Present value of future payments discounted at the market rate

When the price of the bond is equal to its face value sold “at par”

When the price of the bond is greater than the face value sold “at premium”

When the price of the bond is less than the face value sold “at discount”

Price (Proceeds) = PYNT x Present Value Annuity Factor r%, n + Principal x PVAFr%, n

Where r% = market rate of interest payment

Where n = number of interest payments

Bonds normally pay interest annually or semi-annually

A 10 year annual interest bond 10 interest payments (n=10)

A 10 year semi-annual interest bond 20 interest payments (n=20)

PYNT = Face Value x Stated Rate

Price of bonds is inversely related to the market rate

o As r% increases, PV decreases therefore Price of bonds decrease

o As r% decreases, PV increases therefore Price of bonds increase

If Price (Proceeds) < Face Value market rate > stated rate

If Price (Proceeds) > Face Value market rate < stated rate

If Price (Proceeds) = Face Value market rate = stated rate

SE8-9

a) Premium

b) Premium

c) Discount

Quoting Bond Prices

Bonds are quoted ( again newspapers)

Using a base value of 100

o Price of 100 Par Value

o Price < 100 Discount

o Price > 100 Premium

SE8-10

Halderman: Proceeds = 20,000 x 106% = 20,000 x 1.06 = 21,200

Erlichman: Proceeds = 100,000 x 99% = 100,000 x 0.99 = 99,000

Carl: Proceeds = $500,000 x 96.5% = 500,000 x 0.965 = 482,500