MGMT 200 Purdue Chapter 9

capital structure

mixture of liabilities and stockholder's equity a business uses

debt financing

borrowing money

equity financing

obtaining investment from stockholders

cost of financing - debt interest expense

tax deductible

cost of financing - equity dividends

not tax deductible

examples of debt

notes, leases, bonds

installment notes

payment in monthly installments rather than single amount at maturity

installment periods

interest on borrowed amount, reduction of outstaying loan balance

recording establishment of notes payable

debit cash

credit notes payable

recording the first two month payments of loan

debit interest expense

credit notes payable

credit cash

lease

contractual arrangement by which the lessor provides the leases the right to use an asset for a period of tiem

recording for lease (by leasee)

debit lease asset

credit lease payable

what is lease payable

present value of the lease payments, beginning of lease term

why do companies lease rather than buy

reduces upfront cash needed to use asset

payments are often lower than installment payments

offers flexibility and lowers cost when disposing of asset

offer protection against ht risk of declining asset values

recording lease payable (at beginning)

debit lease asset

credit lease payable

bonds

formal debt instrument issued by a company to borrow money

issuing company promises to pay back investor

stat the amount at the specific maturity date, periodic interest payments offer life of bond

when is interest on bonds paid

semiannually on interest dates beginning 6 months after issue date

recording bond issuance

debit cash

credit bonds payable

recording interest payments

debit interest expense

credit cash

recording retiring a bond

debit ponds payable

credit cash

bond characteristics - secured

bonds are backed by collateral

bond characteristics - unsecured

bonds are not backed by collateral

bond characteristics - term

bond issue matures on a single date

bond characteristics - callable

issuing a company can pay off bonds early

bond characteristics - convertible

investor can convert bonds to common stock

retirement of bonds before maturity

can retire bonds early by purchasing them on the open market

what is one of the first places to look when controlling risk

long term debt - debt to equity and times interest earned ratios

higher debit to equity ratio

higher risk of bankruptcy, more debt risk increases

times interest earned ratio

indication to creditors of how many "times" greater earnings are rather than interest expense

time value of money

interest causes value of money received today to be greater than the value of the same amount in the future

simple interst

earned on initial investment only

compound interest

earned on initial investment and on previous interest

annuity

cash payment of equal amounts of time periods of equal length