Multiple Choice
Given three bonds, each with a \$1,000 par value, which of the following correctly calculates the annual interest payment for a bond with a 6% coupon rate?
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11. Long Term Liabilities
Introduction to Bonds and Bond Characteristics
Multiple Choice
Which of the following is an advantage of bond financing for a company?
A
Bond financing increases the company's financial risk due to fixed interest obligations.
B
Issuing bonds dilutes existing shareholders' ownership.
C
Interest payments on bonds are tax-deductible, reducing the company's taxable income.
D
Bonds must be repaid at maturity, which can strain company resources.
Verified step by step guidance1
Understand the concept of bond financing: Bond financing involves a company borrowing money from investors by issuing bonds. The company agrees to pay periodic interest and repay the principal amount at maturity.
Analyze the advantages and disadvantages of bond financing: Advantages include tax-deductible interest payments, which reduce taxable income. Disadvantages include increased financial risk due to fixed interest obligations and the requirement to repay the principal at maturity.
Focus on the tax-deductibility of interest payments: Interest payments on bonds are considered an expense and can be deducted from taxable income, which lowers the company's tax liability. This is a key advantage of bond financing.
Compare bond financing to equity financing: Unlike issuing stock, bond financing does not dilute ownership of existing shareholders. This makes it an attractive option for companies that want to retain control while raising funds.
Conclude why tax-deductible interest payments are advantageous: By reducing taxable income, the company can save on taxes, making bond financing a cost-effective method of raising capital despite its associated risks.
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