Abstract
Long-term debt is the term given to those obligations the firm does not have to pay for at least a year. They are also called funded debt or fixed liabilities. Items that may be classed as long-term debt are bonds, debentures, term loans, or, in small firms, mortgages on buildings. The portion of the long-term debt due within the current year is carried in the current liability section of the balance sheet. Firms in the US issue far more debt than equity shares. In most years during the 1963–2003 period, firms have issued six to eight times more debt than equity. (Of course, most increase in equity is through retained earnings.) Issuing debt raises capital for firm growth and expansion without possibly lessening current stockholder control. The floatation costs are less on debt than on equity, and the cost of debt is less than the expected shareholder return on equity.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
The trustee is compensated with an annual fee. The business of being a trustee for major corporation issues is concentrated among the larger commercial banks.
- 2.
The depreciation charges, although they reduce reported accounting earnings, are not a current out-of-pocket expense. See chapters “The Corporation Balance Sheet” and “The Annual Operating Statements: The Income Statement and Cash Flow Statement”.
- 3.
To provide a little “sweetening” to attract the investor, the subordinated debentures are often convertible.
- 4.
A chattel mortgage is placed against personality, movable or personal property, as distinguished from realty, i.e., land and building.
- 5.
In 2003, the S&P 500 Index firms disclosed $482 billion of off-balance sheet operating lease commitments in their footnotes. J. Weil, “Lease Accounting: Accounting Still has an Impact,” Wall Street Journal, September 22, 2004, A5–A6.
The operating lease commitments were approximately 8% of reported debt of the S&P firms. For many firms, operating lease obligations are much higher. When UAL, the parent firm of United Airlines files for bankruptcy in December 2002, its assets were $ 24.5 billion, its liabilities were $ 22.2 billion, and its non-cancelable operating lease commitments were $24.5 billion (for aircraft). US Airways had substantial operating obligations at the time of its bankruptcy.
- 6.
One must discount the difference between the forecasted after-tax cash flow for the project under a purchase plan and under a rental arrangement, in order to obtain the implicit rate of return on the additional funds required under an outright purchase plan. In general, the rate of return is obtained mathematically by finding the discount factor which equates the cash flow plus any remainder value of the assets with the original investment.
- 7.
These savings accrue because no deduction would be left for depreciation were the firm to keep the title to the property.
- 8.
Suppose a firm is given customary terms of 2/10 n/30 e.o.m. This means the firm may deduct 2% from the monthly statement if it pays within the first 10 days of the month. If it misses this period, the gross amount is due 30 days from the statement date. The 2% discount lost if the firm does not pay within 10 days of the monthly statement amounts to 36% on an annual basis.
- 9.
Although the short term rate went to 22.0% as against 13% on long-term treasuries, subsequently as the rate of inflation fell, the interest rates declined, and the long-term bonds proved to be the better investment.
- 10.
- 11.
This cannot be obtained for the bond directly from the market because the effect of a drop in interest rates combined with a call price may force the bond investors into a locked-in position. They cannot sell at the call price or lower without losing on the interest rate; potential buyers cannot purchase above the call price because of the obvious danger of having the bonds called in by the company at the lower price. Any sales recorded during such a period are not likely to be normal market sales.
- 12.
Warrants sometimes appear after reorganizations, when they are given to the stockholders allowing them the chance to get back into the company if the reorganized company should do better than its failed predecessor.
- 13.
American Telephone and Telegraph Company for years raised equity funds by issuing rights to the stockholders for convertible debentures priced below their conversion value.
- 14.
This is probably true of the subordinated debentures—a popular security of the large finance companies, which is made more acceptable to the market by its convertible feature.
- 15.
The Small Business Investment Companies are the outgrowth of the Federal Small Business Act of 1958. A major objective of the Act is to help make more long-term capital available for smaller firms.
- 16.
See W. Bradford Hickman, Corporate Bond Quality and Investor Experience, Princeton University Press, 1958.
- 17.
The elasticity concept is proportional to the duration concept. Duration measures the sensitivity of bond prices to changes in the yield curve. The yield curve can slope and shift in different scenarios. The duration of a bond may be found by solving the equation:
\( \frac{\mathrm{dP}}{\mathrm{P}}=-{\mathrm{D}}_{\mathrm{i}}\mathrm{dr} \)
where
-
P = bond price,
-
dP = change in bond price,
-
dr = change in interest rates,
-
D = duration.
\( {\mathrm{D}}_{\mathrm{i}}=\frac{-\frac{\mathrm{dP}}{\mathrm{P}}}{\mathrm{dr}}. \)
-
- 18.
One may be tempted to draw an analogy on the financial side to Alfred Marshall’s categories of the young and vigorous, the mature, and, finally, the old or senile firm.
- 19.
Of course, if the firm suffers steep losses in the liquidation of current assets, it may experience a stringency of cash.
- 20.
Sinking funds may be advantageous on municipal issues if the yield on safe taxable federal bonds is higher than the rate on the tax exempt local bonds. The sinking fund trustees should be careful, however, to choose the maturities of the sinking fund investments to coincide with the due dates of their own bonds if they wish to avoid the possibility of capital losses on the sinking fund assets.
- 21.
Bonds may also be retired by tender, where bondholders are invited to submit the price at which they are willing to sell their bonds back to the company. The company picks up the bonds tendered at the lowest prices.
- 22.
In rare cases the conversion must be accompanied by a payment of money. The company not only retires the debt issue, it increases equity capital and strengthens its working capital position.
Reference
Bierman, H. (1972). The bond refunding decision. Financial Management, 22–29.
Brealey, R. A., & Myers, S. C. (2003). Principles of corporate finance (7th ed.). Boston, MA: McGraw-Hill/Irwin. Chapter 26.
Guerard Jr., J. B. (2010). The corporate sector as a net exporter of funds. In J. R. Aronson, H. L. Parmet, & R. J. Thorton (Eds.), Variations in economic analysis: essays in Honor of Eli Schwartz. New York: Springer.
Hicks, J. R. (1937). Value and capital. London: Oxford University Press.
Macaulay, F. R. (1938). Some theoretical problems suggested by the movements of interest rates. New York: Columbia University Press.
Malkiel, B. G. (1962a). Expectations, bond prices, and the term structure of interest rates. Quarterly Journal of Economics, 76, 197–218.
Malkiel, B. G. (1962b). The term structure of interest rates. American Economic Review, 54, 532–543.
Myers, S. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 5, 147–176.
Schwartz, E. (1962). Corporate finance. New York: St. Martin’s Press, Chapter 9.
Schwartz, E. (1967). The refunding decision. Journal of Business, 40, 448–449.
Van Horne, J. C. (2002a). Financial management & policy (12th ed.). Upper Saddle River: Prentice Hall. Chapter 18.
Van Horne, J. C. (2002b). Financial market rates and flows (6th ed.). New York: Prentice-Hall, Inc..
Author information
Authors and Affiliations
Rights and permissions
Copyright information
© 2021 Springer Nature Switzerland AG
About this chapter
Cite this chapter
Guerard, J.B., Saxena, A., Gultekin, M. (2021). Long-Term Debt. In: Quantitative Corporate Finance. Springer, Cham. https://doi.org/10.1007/978-3-030-43547-9_9
Download citation
DOI: https://doi.org/10.1007/978-3-030-43547-9_9
Published:
Publisher Name: Springer, Cham
Print ISBN: 978-3-030-43546-2
Online ISBN: 978-3-030-43547-9
eBook Packages: HistoryHistory (R0)