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13.1 Explain the Pricing of Long-Term Liabilities

Long-Term Liabilities​

Long-term liabilities include:

  • Long-term loans
  • Bonds payable
  • Mortgages
  • Lease obligations
  • Other obligations due beyond one year

Characteristics:

  • Due beyond one year (or operating cycle if longer)
  • Usually involve interest
  • Require periodic payments
  • Affect financial leverage
  • Important for cash flow planning

Pricing Long-Term Liabilities​

Present Value Concept:

  • Long-term liabilities are recorded at present value
  • Present value considers time value of money
  • Interest rate affects present value
  • Reflects current economic value

Time Value of Money:

  • Money today is worth more than money in the future
  • Interest compensates for time
  • Present value discounts future payments

Face Value vs. Present Value:

  • Face Value: Amount to be repaid at maturity (principal)
  • Present Value: Current value considering interest
  • If market rate = stated rate: Present value = Face value
  • If market rate > stated rate: Present value < Face value (discount)
  • If market rate < stated rate: Present value > Face value (premium)

Example: Loan Pricing​

Scenario:

  • Loan amount: €100,000
  • Interest rate: 5% per year
  • Term: 5 years
  • Annual payment: €23,097.48

If Market Rate = 5%:

  • Present value = €100,000 (face value)
  • No discount or premium

If Market Rate = 6%:

  • Present value < €100,000 (discount)
  • Loan is worth less than face value

If Market Rate = 4%:

  • Present value > €100,000 (premium)
  • Loan is worth more than face value

Luxembourg Compliance Note​

Long-term liabilities in Luxembourg:

  • Must be properly classified (PCN Class 1)
  • Must be recorded at appropriate value
  • Must accrue interest properly
  • Must comply with accounting standards
  • Must maintain documentation
  • Must separate current and long-term portions

Think It Through​

Why is present value important for long-term liabilities? How does it differ from face value? What happens if market rates change after a loan is issued?