Essay on Finance and Long Term Capital

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Bonds - Premium or Discount

Ursula Gonzales ACC/291 November 29, 2014 Daniel Carraher

Bonds - Premium or Discount

Bonds are a form of interest-bearing notes payable; obtaining large amounts of long-term capital (long term capital movements include FDI and movements of financial capital with maturity of more than one year, this includes equities) (Long term Capital, 2014). Upper management usually has to decide whether to issue common stock, equity financing or bonds (Accounting Coach, 2013). Issuing bonds is so they don’t affect stockholder control. Do to the fact that bondholders do not have voting rights; business owners can raise capital with bonds and still maintain corporate control. Bonds are appealing to corporations because the cost of bond interest is tax-deductible. This tax break treatment may cause bonds to result in lower cost of capital than in equity financing. A possible disadvantage in using bonds is that the company must pay interest on a periodic basis; the business must also repay the principal at the due date. A business with fluctuating earnings and or a weak cash position may have great difficulty making interest payments when earnings are low. A business may also get long-term financing from leasing and notes payable (Weygandt, J.J., Kimmel, P.D., & Kieso, D.E. 2010). Although, notes payable and leasing are rarely sufficient to sustain the amount of funds needed for company expansion and major projects like new structures. Bonds are sold in relatively small denominations usually $1,000 multiples so as to be truly beneficial. Because of their size, and the variety of their benefits. Bonds attract many investors with their features that include secured and unsecured bonds, term and serial bonds, registered and unregistered bonds, and convertible and callable bonds (Long term Capital, 2014).

The determining factor of a bond is called the time value of money. The amount that must be invested today at a given rate of interest over a specified time is called present value. The present value of a bond is the value at which it should sell in the marketplace. Market value therefore is a function of the three factors that determine present value: the dollar amounts to be received, the length of time until the amounts are received, and the market rate of interest. The market interest rate is the rate investors demand for loaning funds (Weygandt, J.J., Kimmel, P.D., & Kieso, D.E. 2010). When a corporation is preparing a bond to be issued/sold to investors, it may have to anticipate the interest rate to appear on the face of the bond and in its legal contract. “Assuming that the corporation prepares a $100,000 bond with an interest rate of 9%. Just prior to issuing the bond, a financial crisis occurs and the market interest rate for this type of bond increases to 10%. If the corporation goes forward and sells its 9% bond in the 10% market, it will receive less than $100,000. When a bond is sold for less than its face amount, it is sold at a discount.” (Accounting Coach, 2013). The discount is the difference between the amount received not including accrued interest and the bond's face amount. One would know the difference by the terms discount on bonds payable, bond discount, or discount (Long term Capital, 2014).

References

Weygandt, J.J., Kimmel, P.D., & Kieso, D.E. (2010). Financial accounting (7th ed.). Hoboken, NJ: John Wiley & Sons.

"Long-term Capital." What Is Long-term Capital? Definition and Meaning. N.p., n.d. Web. 30 Nov. 2014

"Bond Discount with Straight-Line Amortization | AccountingCoach."AccountingCoach.com. N.p., 2013. Web. 30 Nov. 2014.

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