The long term debt that matures in 2007 amounts to $ 33,000,000.
The long term debt that matures in the next five year time frame is:
Year
Value of Long-Term Debt
$ (millions)
2007
33
2008
175
2009
436
2010
54
2011
522
Question 3
When a financial analysis is performed on the financial statements of an organization, the financial performance, position and stability of the firm will be considered. The financial analyst will not concentrate solely on the profitability and working capital management of the firm. He will also examine the company’s ability to meet its long-term obligations as they become due. This is important because if a firm cannot pay back its debts it can end up in bankruptcy. A positive profitability every year does not necessarily ensure that the firm possesses sufficient cash to pay back its debts. We ought to keep in mind that the income statement is prepared under the accruals basis of accounting, which states that revenue/expenditure incurred but not yet received/paid should be included in the profit and loss account in the period it arose (McKenzie W. 2003, p 6-7). In fact, in practice a number of accounting ratios like the gearing ratio, interest cover and more are adopted to assess the long-term solvency of the corporation due to the aforementioned features (McKenzie W. 2003, p 208-217).
The management of Coca Cola Company can either repay the loan commitments from the cash generated from the firm’s operations and/or utilize equity finance to settle such debts. They can also adopt some form of short-term debt finance if they expect difficulty in using the previous mentioned methods. For instance they can utilize or extend the overdraft facility.
Question 5
The calculation of the interest expense on long-term debts for 2007:
Debt
Working
Interest Expense
$ (millions)
Due in 2009
(366 x 5.75%)
21.045
Due in 2011
(499 x 5.75%
28.6925
Due in 2093
(116 x 7.375%)
8.555
Due through 2014
(333 x 6%)
19.98
Total interest expense
78.2725
Question 6
In practice a number of different debts can be issued. All possess different features and can also pose a differing effect on the interest charged. In the fourth question we calculated the interest rate by considering the firm’s debts cumulatively. However, if the corporation held debts like deep-discount bonds, our calculation would be incorrect. Such bonds are debts issued at a price below the par value of the bond, commonly known as deep-discount. These types of bonds carry no entitlement to interest as such and therefore the inclusion of them in the interest rate calculation would be incorrect (Pike R. et al 1999, p 508).
A bond issued at a premium also poses errors if the approach in question four is adopted. This is due to the fact that such bonds frequently entail a higher rate of interest than the normal bonds.
Question 7
Organizations that hold a significant amount of debt should be very careful to interest rate fluctuations, which may pose a substantial burden on the corporation. The effect of increasing interest rate on a company that holds $1,314 million of debts, like Coca Cola Company will definitely be material even if it is by 0.5%. Meticulous companies like the one mentioned adopt interest rate management instruments to minimize the exposure of the firm to changes in the interest rate. There are a number of methods to manage interest rate risk. These are explained below (Pike R. et al 1999, p 370 -371):
· Interest rate mix – this entails a mix of fixed and variable rate debts in order to minimize the materiality of the effects of unexpected rate movements.
· Forward rate agreement – the adoption of a forward rate agreement with a bank can also mitigate interest rate risk. This would lock the organization into borrowing at a future date at a set interest rate.
· Interest rate ‘cap’ – a firm can also ‘cap’ the interest rat in order to remove the aforementioned risk. This is achieved by setting an upper limit on the rate the business enterprise pays for borrowing a specified sum. Unlike the previous method, if the interest rate falls, the corporation is not obliged to compensate the bank in such instances.
· Interest rate futures – such contracts comprise the hedging of large interest exposures by utilizing relatively small outlays. Interest rate futures are similar to forward rate agreements with the exception that the amounts and periods are standardized.
· Interest rate options – these types of contracts, also known as interest rate guarantees, grant the right to the buyer but not the obligation to deal the debt at set interest rates in the future.
· Interest rate swaps – this latter method is applicable for companies with predominantly variable rate debt match its debt with the expectation that interest rate will rise, with an organization that also principally possesses fixed-rate debts anticipating that interest rates will fall. Banks are normally used as intermediaries in such process. Each firm will still remain accountable for the original loan obligation. Exchanges of differing currencies are also sometimes entailed in this interest rate management instrument.
Question 8
As already stated in question 3, a company can repay the long-term debts upon maturity by utilizing the cash generated from the firm’s operations. Unluckily frequently a firm does not hold sufficient cash flow for such commitments and trouble arise when they fall due. A number of short-term finance mediums can be adopted in this respect (Washington State University). These are listed and explained below:
· Trade creditors – Coca Cola Company can sustain the financial position of the firm during such periods by negotiating more favorable terms with the suppliers and other trade creditors of the firm. Coca Cola Company possesses a very good reputation in the market. Through proper negotiation techniques they can increase the average payment period of creditors in order to aid the firm’s working capital position during such periods.
· Factoring – this method basically entails raising funds on the securities of the company’s debts in order to receive cash from the debtors of the firm earlier than the credit date set. In practice factoring companies offer a different number of services, such as guarantee on bad debts. In the situation provided in the question the corporation should seek companies that provide the advancement of money of up to say 80% of the trade debts owed to the company.
· Invoice discounting – such method comprises the transfer of invoices to a finance house in exchange of cash. Again this method aids the liquidity position of the business enterprise by sending respective invoices to the finance house with the commitment of payment of any debts that are purchased. Thus an advance payment of say 75% will be provided by this institution with the obligation that the company will pay back the debt in a time frame of for example 95 days. In these instances the organization is accountable for the collection of the debt of payment of amount advanced when the debt is collected.
· Bank overdraft facility – if the organization hold a substantial amount of assets and is performing a good financial performance, the firm can enter into a bank overdraft facility or extend the limit of its present facility if it already holds one to finance such loan commitment. It is imperative that the company financial health is sound because this type of short-term finance is repayable on demand and holds interest liabilities too.
Reference:
McKenzie W. (2003). Using and Interpreting Company Accounts. Third Edition. Harlow: Pearson Education Limited.
Pike R.; Neale B. (1999). Corporate Finance and Investment. Third Edition. London: Prentice Hall.
Washington State University. Short Term Sources of Finance (on line). Available from: http://cbdd.wsu.edu/kewlcontent/cdoutput/TOM505/page36.htm (Accessed 22nd April 2007).
