Questions about Chapter 14 – Long-Term Financing Instruments
Questions for Review
Chapter 14
Long-Term Financing
Solutions
1) A secured loan has collateral, while an unsecured does not. If a firm goes bankrupt, the unsecured creditors get paid from the pool of resources left over after the secured creditors claim the assets that secured their loans.
2) Down.
3) Using Time Value of Money, solve for the PMT.
4) It is used to compute the periodic interest payments. It is NOT used to compute the price the bond would sell for. The current market rate is used for that computation.
5) 30 year bond less 10 years gone by = 20 years × 2 payments per year = 40 nper
$10,000 bond × 5% = $500 interest payment per year × 1/2 year = $250 pmt
4.5% current market rate × 1/2 year = 2.25% per 6 month compounding period
=PV(rate, nper, pmt, fv, type)
=PV(2.25%, 40, 250, 10000, 0)
=($10,654.84)
The bond would sell for $10,654.84 today. The computation shows a negative, because this is the amount someone would PAY today to buy the bond.
6) A lease provides flexibility. You don’t have to make a down payment as you would if you bought the asset and took out a mortgage on it, so you can effectively get 100% financing. You don’t have to deal with the hassle of selling used equipment if you only need it for part of its useful life. Also, you can protect yourself against obsolescence with a cancelable lease. You may be able to save money on maintenance of the equipment.
7) A leasing company adds another profit-maker to the mix. This usually means the cost of leasing is higher than the cost of just borrowing money and buying the asset. Also, the leasing company has higher risk, and charges you for taking that risk. If you lease, you give up the benefits of ownership. Often leased property still has substantial value left at the end of the lease. If you had purchased it, you might be able to sell it at a profit.
8) Even if leasing would otherwise seem to be more costly, when taxes are taken into account, it may still pay to lease. Sometimes you reduce total taxes paid by shifting deductions from a low tax bracket individual or company to a higher bracket payer, if the low bracket payer leases the asset from the high one. Since the higher tax bracket payer saves ontaxes, they can share that benefit with the person or company in the lower bracket by lowering the lease payment. There are also potential tax savings from sale and leaseback arrangements. Sometimes leasingcan be used to minimize the Alternative Minimum Tax as well.
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Solution Preview
Bonds
Q1
A secured loan contains collateral, while unsecured lacks collateral. When a firm goes bankrupt, the secured loan is paid by the collateral that had been put in place while the unsecured loan is deducted after the secured loan is fully paid.
Q2
Over time, the interest portion of each mortgage payment goes down because the total amount becomes depleted with time.
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