CHAPTER 18 LONG-TERM FINANCING I Questions Three major sources of long-term financing for a corporation are bonds, preferred stock, and common stock A bond is a security that carries a promise to pay interest and principal at specified dates An indenture is the agreement under which a bond is issued There are three parties to a public bond issue: the issuer, the bondholders, and the trustee The trustee is largely responsible for enforcing the provisions of the bond indenture on behalf of the bondholders Bonds may be either secured or unsecured Secured bonds are backed by a pledge of certain types of property whereas unsecured bonds are not secured by specific property The major advantages of bond financing include relatively low cost, no dilution of control, financing flexibility, financial leverage, lower risk than short-term debt, and an inflation hedge The disadvantages of bonds include increased financial and default risk, restrictions on operations, a definite maturity date, and limits of debt in the firm’s financial structure Preferred stock is a hybrid security because it has characteristics of both debt and equity The basic advantages for the use of preferred stock financing include the ability to increase financial leverage, the flexibility of the issue, the absence of control dilution, and the preservation of assets for collateral 10 Disadvantages of preferred stock include its relatively high cost and its preference over the common stockholders 11 Common stockholders have numerous rights including voting rights, the right to dividends (if declared), the right to any remaining assets upon liquidation, the right to transfer their ownership, and the preemptive right 18-2 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations 12 The basic advantages of common stock stem from the fact that this source of financing places minimum constraints on the firm Common stock gives a firm flexibility because it has no fixed charges and no maturity date 13 Disadvantages of common stock include its high cost, potential dilution of control and earnings, and loss of leverage II True or False False True True False True 10 True True True False True 11 12 13 14 15 False True False True True III Practical Problems PROBLEM (a) The total amount of semiannual interest is: (0.09 x P2,000,000) / = P90,000 (b) The after-tax cost of the semiannual interest payments is: P90,000 x (1 – 0.34) = P59,400 PROBLEM The following computations show that Supreme Hotel has a net investment of P1,252,600 in the refunding Initial cash outflows Cost of calling old bonds (P1,120 x 10,000 bonds) P11,200,000 Overlapping interest on old bonds [(2 / 12) x 0.15 x P10,000,000] 250,000 Flotation costs of new bonds 350,000 Initial cash outflows P11,800,000 Initial cash inflows Proceeds from new bonds P10,000,000 Tax savings Call premium on old bonds (0.12 x P10,000,000 x 0.34) 408,000 Unamortized flotation costs on old bonds [(20 / 30) x P240,000 x 0.34] 54,400 Overlapping interest on old bonds [(2 / 12) x 0.15 x P10,000,000 x 0.34] 85,000 Long-term Financing 18-3 Initial cash inflows P10,547,400 Initial net cash inflows Initial cash outflows P11,800,000 Initial cash inflows 10,547,400 Initial net cash outflows (net investment) P 1,252,600 PROBLEM Northpark Noodles Company has issued 140,000 shares (0.70 x 200,000 shares) and repurchased 14,000 (0.10 x 140,000) of these shares Hence, the total number of shares outstanding is the number of issued shares less treasury stock or 126,000 shares (140,000 – 14,000) PROBLEM The P3,200,000 (P16 x 200,000 shares) is recorded from the stock sale and is separated into two accounts: common stock and additional paid-in capital The common stock account is P200,000 (P1 par x 200,000 shares) and the additional paid-in capital account is P3,000,000 (P15 x 200,000 shares) The balance sheet accounts are shown below: Stockholders’ Equity Common stock (500,000 shares authorized and 200,000 shares issued and outstanding at P1 par) P 200,000 Additional paid-in capital 3,000,000 Total stockholders’ equity P 3,200,000 .. .18- 2 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations 12 The basic advantages of common stock stem... flexibility because it has no fixed charges and no maturity date 13 Disadvantages of common stock include its high cost, potential dilution of control and earnings, and loss of leverage II True or False... recorded from the stock sale and is separated into two accounts: common stock and additional paid-in capital The common stock account is P200,000 (P1 par x 200,000 shares) and the additional paid-in