Analyzing Debt Terms, Yields, Prices, and Credit Ratings

Reproduced below is the debt footnote from the 2016 10-K report of Oracle Corporation.

Analyzing Debt Terms, Yields, Prices, and Credit Ratings Reproduced below is the debt footnote from the 2016 10-K report of Oracle Corpor May 31, 2016 May 31, 2015 $3.750 1.000 500 750 1.000 500 750 2.000 2.500 2.500 1.500 1.750 2.000 1,000 1.352 $ millions Revolving credit agreements: $3,750, LIBOR plus 0.35%, due June 2016 Floating-rate senior notes: $1,000 three-month LIBOR plus 0.20%, due July 2017 5500, three-month LIBOR plus 0.58%, due January 2019 $750, three-month LIBOR plus 0.51% due October 2019 Fixed-rate senior notes: $2,000. 5.25%, due January 2016 $2,500, 1.20%, due October 2017 $2.500.5.75%, due April 2018 $1,500, 2.375%, due January 2019 $1,750. 5.00%, due July 2019 $2,000, 2.25%, due October 2019 $1,000, 3.875%, due July 2020 1,250, 2.25%, due January 2021 $1,500, 2.80%, due July 2021 $2,500, 2.50%, due May 2022 $2,500, 2.50%, due October 2022 $1,0003.625%, due July 2023 $2,000, 3.40%, due July 2024 $2.500 2.95%, due May 2025 750, 3.125%, due July 2025 5500, 3.25%, due May 2030 $1,750, 4.30%, due July 2034 $1,250, 3.90%, due May 2035 $1,250, 6.50%, due April 2038 $1,250, 6.125%, due July 2039 52.250.5.375%, due July 2040 51,000, 4.50%, due July 2044 $2,000, 4.125%, due May 2045 $1,250, 4.375%, due May 2055 Total senior notes and other borrowings Unamortized discount/issuance costs Hedge accounting fair value adjustments Total notes payable and other borrowings Notes payable and other borrowings, current Notes payable, non-current 2.500 1.000 2.000 2.500 810 2.500 2.500 1.500 1.750 2.000 1,000 1.394 1,500 2.500 2.500 1,000 2.000 2.500 836 500 1.750 1.250 1.250 1.250 2.250 1,000 2.000 1.250 43.980 (247) 122 43.855 (3.750) $40.105 500 1.750 1.250 1.250 1.250 2.250 1.000 2.000 1.250 42.162 (278) 74 41.958 (1.999) $39.959 Future principal payments (adjusted for the effects of the cross-currency swap agreements associated with the January 2021 Notes) for all of our borrowings at May 31, 2016 were as follows: $ millions Fiscal 2017 $3,750 Fiscal 2018 6.000 Fiscal 2019 2.000 Fiscal 2020 4.500 Fiscal 2021 2,655 Thereafter 25.336 Total $44,241 Reproduced below is a summary of the market values as of December 2016 of select Oracle bonds (from Morningstar, www.morningstar.com). Name Oracle 2.95% Oracle 4% Maturity Date 5/15/25 7/15/46 Yield to Amount $ Price Coupon % Maturity % 2.500 97.9 2.950 3.23 3.000 0 94.3 243 4.000 4.34 4.76 a) What is the amount of debt reported on Oracle's May 31, 2016 balance sheet? 50 million What are the scheduled maturities for this indebtedness? 2017 $ 2018 5 2019 $ 2020 $ 2021 $ Thereafter 5 3.750 million 6.000 million 2.000 million 4.500 million 2,655 million 25.336 million Why is information relating to a company's scheduled maturities of debt useful in an analysis of its financial condition? Excessive payments in any one year can create a cash flow problem, especially if the debt cannot be refinanced. We prefer to see liabilities coming due in the near future if interest rates are expected to decline; but deferred if interest rates are expected to increase. The information relating to a company's scheduled maturities is not important. We are looking to see if all payments are approximately equal. If so, the expected drain on cash flow will be constant. (6) Oracle reported $1,467 million in interest expense in the notes to its 2016 income statement. In the note to its statement of cash flows, Oracle indicates that the cash portion of this expense is $1,616 million. What could account for the difference between interest expense and interest paid? The difference arises from the amortization of any discounts or premiums on the debt. The difference arises because the amount of interest paid is based on prevailing interest rates that change frequently. The difference arises because the amount of interest expense is based on prevailing interest rates that change frequently. There is never any difference between interest expense and interest paid. (c) Oracle's long-term debt is rated A1 by Moody's, A+ by S&P, and A+ by Fitch. What factors would be important to consider in attempting to quantify the relative riskiness of Oracle compared with other borrowers? Credit rating agencies assess companies' default risk by focusing primarily on macroeconomic factors such as the projected level of interest rates. Credit rating agencies assess companies' default risk by gauging the level of debt in relation to the companies' operating cash flow, profitability ratios, and the ratios for long-term creditworthiness. Credit rating agencies assess companies' default risk by comparing the target company against companies that have defaulted on their debt. Credit rating agencies assess companies' default risk by focusing primarily on non-quantitative measures such as the quality of the company's management team. (d) Oracle's $3,000 million 4% notes traded at 94.3 or 94.3% of par, as of December 2016. What is the market value of these notes on that date? (Round your answer to one decimal place.) $0 million How is the difference between this market value and the $3,000 million face value reflected in Oracle's financial statements? The balance sheet is unaffected, but the income statement reflects increases (decreases) in interest rates as increases (decreases) in interest expense. The current market value of the notes is reflected in the balance sheet as an increase (decrease) in liabilities if rates have declined (increased) Only the statement of cash flows is affected as cash is needed to retire the liabilities when they mature. The current market value of the notes is not reflected in Oracle's balance sheet. What effect would the repurchase of this entire note issue have on Oracle's financial statements? There would be no effect on the financial statements if Oracle were to repurchase these notes because the repurchase would be made at book value. Oracle is prohibited from repurchasing the notes before maturity and, thus, no financial statements would be affected. Only the balance sheet and statement of cash flows would be affected as they reflect the cash payment and consequent reduction of liabilities. olf Oracle were to repurchase these notes, the difference would be reported as a gain in the current income statement. What does the 94.3 price tell you about the general trend in interest rates since Oracle sold this bond issue? The price of the bonds is unrelated to the general level of interest rates, only the rate of interest on Oracle's debt. Because that hasn't changed, other causes must be considered. Because these notes have declined in value subsequent to their issuance, market interest rates must have decreased. Because these notes have declined in value subsequent to their issuance, market interest rates must have increased. (e) Examine the yields to maturity of the three bonds in the table above. What relation do we observe between these yields and the maturities of the bonds? Also, explain why this relation applies in general. The table generally reveals the following relation: the longer the time to maturity, the higher the yield. Typically, there is an increasing relation between the term period of the debt and its yield. The table generally reveals the following relation: the shorter the time to maturity, the higher the yield. Typically, there is an inverse relation between the term period of the debt and its yield