Transcript MBA Module 8 PPT - Texas Tech University

Accounting Equation: Another Look
Everything we have came from somewhere.
Focuses on Liabilities
Liabilities
Line of credit needed--Quick borrowing
power in cash for stressed times
Interest expense non-value added to
customers,
except
for
financial
institution.
No real excuse for running out of money—
have a good cash plan.
Liabilities
Liabilities creates added risk

High risk--agriculture, small business...
debt (0-10%), need high equity

Medium risk companies--large, service,
manufactures--modest debt (20-50%--no more
than 60% of total assets), good equity

Low risk—utilities or financial can take on
substantial debt (50%-80%), adequate equity
little
SHORTAGE

"Keep the wolf from the door."
Schedule out receipts and payments
expected by day for the month.
 Sell something, if possible (often not)

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Borrow more, if possible (often not)
SHORTAGE

Examine contracts for advances
possible on partial completion of
work.
Opportunity to become more
efficient quickly--cut all NVA
activities.
 Press late paying customers to
pay on time.

Ethical Payments?

Payments, in dire circumstances
Mail to vendor's place of business
Mail on Mon. or Tues., not Fri.
Use regular envelope, not vendor's
MORE DRASTIC ACTION

Lengthen creditor terms--unsecured
first, “Lean on the Trade”
If good customer, then they will lengthen
 If poor customer, suppliers often react with
COD terms.

Restructure loans
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Renegotiate loans with creditors
 Interest rates reduced
 Principal payments extended

Court Protection (almost over)
Voluntary bankruptcy procedure to give
time to work out difficulties (Chapter
11), few survive this.
Do not favor one creditor or make
personal use of assets.
If business cannot be turned around,
then minimize losses/liquidate early.
(Chapter 7)
Current Liabilities

Current operating liabilities
 Accounts payable
 Accrued liabilities

Current non-operating liabilities
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Short-term interest-bearing loans
Current maturities of long-term debt
Terms

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Accounts payable carry credit terms such
as 2/10, net 30. These terms give the
buyer, for example, 2% off the invoice
price of goods purchased if paid within 10
days. Otherwise the invoice is payable in
its entirely within 30 days.
Some customers lean too far—they take
the discount and pay late anyway.
Uncertain Accruals

Specifically, if the obligation is probable
and the amount estimable, then a
company will recognize this obligation.
 If only one of the criteria is met, the
contingent liability is disclosed in the
footnotes.
Misreporting of Accruals

The latitude in determining the amount and
timing for recognition of accruals can lead to
misreporting of income and liabilities.
 If accruals are over (under) estimated, then
liabilities are over (under) estimated, income
is under (over) estimated, and equity
(retained earnings) is under (over) estimated.
Short-term Interest-Bearing Loans

Companies generally finance seasonal
swings in working capital with a bank line
of credit.
Bond Pricing
There are two different interest rates you must
understand before we can discuss the mechanics of
bond pricing:
1. Coupon (contract or stated) rate – the stated rate in
the bond contract. It is used to compute the dollar
amount of (semiannual) interest payments that are paid
to bondholders during the life of the bond issue.
2. Market (yield) rate – the interest rate that investors
expect to earn on the investment in the debt security.
This rate is used to price the bond issue.
Cash Flows from Bonds

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To illustrate, assume that investors wish
to price a bond with a face amount of $10
million, an annual coupon rate of 6%
payable semiannually (3% semiannual
rate), and a maturity of 10 years.
Investors purchasing this issue will
receive the following cash flows:
Coupon Rate vs. Market Rate
Bond Pricing:
Coupon Rate = Market Rate (Par)

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Company promises to pay 20 semiannual
payments of $10 million  (6%/2) = $300,000 each,
plus the $10 million face amount of the bond at
maturity, for a total of $16 million.
Assuming that investors desire a 6% annual
market rate of interest (yield), the bond sells for
$10 million:
Bond Pricing:
Coupon Rate > Market Rate (Premium)

Assume that investors expect only a 4%
annual yield (2% semiannual yield). Given
this new discount rate, the bond sells for
$11,635,129 – see below:
Bond
Tombstone
Verizon’s Zero Coupon Debt
Bonds Sold at a Premium
Effective Interest Method
(Premium Example)
Debt
Ratings
Bond Interest Rates
Bond Ratings
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Credit quality is related to default risk.
Companies seeking to obtain bond financing
from the capital markets first seek a rating on
the bond issue from one of several rating
agencies such as Standard & Poor’s, Moody’s
Investor Services or Finch.
The business of these rating agencies is to
rate debt so that its default risk can be
accurately determined and priced by the
market.
Selected Financial Ratios for
Various Bond Rating Classes