Problem Summary Week 5

Long Term Debt

There are four main types:

• Secured Debt: are secured by specific assets such as Mortgage Bonds (if the issuer fails to make the required repayments, lenders can seize the assets), Collateral Trust Bonds (similar to mortgage bonds except that they are secured by equity rather than real property), Equipment Trust Certificates, and Conditional Sales Contracts (usually issued to finance the purchase of aircrafts, railroad engines, and cars).

• Unsecured Debt: consists of notes (maturities lesser of ten years) and debentures (maturities greater than ten years).

• Tax-Exempt Corporate Debt: to encourage investments in certain industries Congress grants firms to issue tax-exempt bonds.

• Convertible Bonds: can be converted into common stock shares at the bondholder’s option.

Long-term Debt Features

• Maturity: date at which the borrower must repay the funds borrowed,

• Principle Amount: amount the borrower must repay at maturity,

• Coupon Rate of Interest: a fixed or variable rate that the borrower must repay through the life of debt.

• Mandatory Redemption (sinking fund) Schedule: is created for the purpose of spreading out the redemption value of the bonds over time to decrease the likelihood of default,

• Optional Redemption Provision: the issuer states that it has the right to call the issue (or part of it) for early redemption. A schedule is specified at the time of issue.

Advantages and Disadvantages of Leasing with Debt vs. Equity

The advantages of leasing with debt are an efficient use of tax deductions and tax credits because the interest of the loan can be deducted on the company’s tax return and reduced costs of borrowing, the lender doesn’t have claim into equity only can obtain repayment for the capital plus interest and not claim on future profit in the organization, and also not dilute the owner’s ownership interest in the company.

The disadvantages of leasing is that as a debt it has to be paid, the interest...