Chapt. 16 LT Debt 1

Long-term Liabilities: BONDSsee “Confederation Bridge…”p. 734 of text

Text pages734757 (no amortization)

DO: P.766+ Questions;

BE16-1,2,3; E16-1,2; P16-4A

Chapt. 16 LT Debt 2

What are bonds? p.736

• Bonds are a form of interest-bearing notes issued by corporations, governments, and governmental agencies.

• Bonds, like common shares, can be sold in small denominations (usually a thousand dollars), and as a result they attract investors.

• Often secured against assets; if unsecured debentures

• priority claim on assets is case of bankruptcy

No ASSET as Collateral

Chapt. 16 LT Debt 3

Financing the Growth of a Company

EQUITYselling (issuing) more

shares of a companyLoss of control /

dilution of ownership of the company

Lower potential EPS

DEBTBorrow large sums of

money required to finance (pay for) big projects

Long-term capital to match the future revenues generated from the acquisition

Chapt. 16 LT Debt 4

BONDS: Pros & Cons p.737

Maintain ownershipInterest is tax deductible (p. 737 ill.16-2)

Lower ROI to creditors than equityInterest Payments = “servicing the debt”Redeem = principal paid back at maturity

Chapt. 16 LT Debt 5

TYPES OF BONDS p.738

• Bonds that mature at a single specified future date are called term bonds.

• In contrast, bonds that mature in installments are called serial bonds.

2000 2001 2002 2003

2000 2001 2002 2003

Chapt. 16 LT Debt 6

TYPES OF BONDS p.738

• Registered bonds are issued in the name of the owner and have interest payments made by cheque to bondholders of record.

• Bearer or coupon bonds are not registered; thus bondholders must send in coupons to receive interest payments.

Chapt. 16 LT Debt 7

TYPES OF BONDS p.738

• Convertible bonds permit bondholders to convert the bonds into common shares at their option.

• Redeemable (callable) bonds are subject to call and retirement at a stated dollar amount prior to maturity at the option of the issuer.

• Retractable bonds are subject toredemption prior to maturity at the option of the holder.

Chapt. 16 LT Debt 8

Bond (NOT James) Bond p. 739+

Issuing Company (borrower)

Interest Rate %(Coupon rate per year paid semi-annually)

When principal is repaid - TIMECurrent trading price cents/$

Effective current ROI

• Market Value discount / premium; Debt “Rating”;

Company Coupon Maturity Price Yield

Loblaws 6.65% Nov8/28 101.81 6.5%

Chapt. 16 LT Debt 9

“what is it worth”?

Market Value discount / premiumDebt “Rating”The market value of a bond is equal to the

present value of all the future cash payments promised by the bond.

Chapt. 16 LT Debt 10

INTEREST RATES AND BOND PRICES, Ill. 16-7, p. 742

4%4%

5%5%

6%6%

PremiumPremium

Face ValueFace Value

DiscountDiscount

Bond Contractual

Interest Rate 5%

Issued when

Market Interest Bonds SellRates at

Chapt. 16 LT Debt 11

Example: Nortel has listed in their AR 200 million 6.88% note (i.e. debt or bonds) due Sept 1, 2023. Issued Sept 1998 at par, semi annual interest

Issue date: Cash 200,000,000Bonds payable 200,000,000

Sept 1, ‘03 Bond Interest Expense 6,880,000Cash 6,880,000

Dec 31 ‘03 Bond interest expense 4,590,000 Accrued interest expense payable 4,590,000

March 1 ‘04 Bond interest expense 2,290,000Bond interest payable 4,590,000

Cash 6,880,000

Sept 1 ’23 Bond payable 200,000,000 Cash 200,000,000