Hi , This is a question from sample exam. At the beginning of the year , two companies issued debt with same market debt ,maturity date, total face value. One company issued coupon bearing bond at par and the other company issued zero coupon bond. All other factors beging equal for taht year ,compared with the company that issued par bonds, the company that issued zero coupon bond will most likey overstate: (A) CFO but not interest expense. OR (B) Both CFO and interset expense ? I know that CFO will be overstated and that interest expense increases each.Does that mean that its oversted? Help is appreciated. Thanks
I think A. There is no interest expense under a zero coupon bond which is why CFO is overstated. If anything, interest expense will be understated for the life of the bond.
A. Zeros are classified as CFF at issuance and maturity, but the “implied” interest expense that results from the amortization of the discount is never accounted for as an operating (interest) expense. Interest expense is correct, because there is really not an expense as no interest is paid, however, the classification of the principal repayment cash flow really belongs to CFO, not CFF.
A. But I think the reason goes as follows…There IS an interest expense in Zero cupon bonds but that is a % of discounted value of bonds and that’s why it is a smaller amount than that of bonds issued at par. There is no change is CFO though coz interest is not paid on zeros.
A tip: zeroes SEVERELY overstate cash flow from ops