Question

Your company is planning on expanding their current facility to increase the manufacturing of their products. The total cost is expected to be $100,000, and the company has decided to finance the project with short-term debt for the company an interest -bearing note or a zero-interest -bearing note. What are the key characteristics and differences between the two? Which one should the company decide to take on and why ? What effect will each bearing note have on the financial statements ?

Answer 1

There are two types of notes receivable
1)    Interest-bearing note; Holder of the note will receive interest payment in addition to the face amount of the note. The rate of interest is implied on the note.

2)    Noninterest-bearing note or a zero-interest -bearing note; Holder of the note will receive the face amount only on due date.

The following are the differences;

1 When a company has no interest-bearing debt, the firm is very stable and if a company has interest bearing note then it is not considered as very sound.
2 No interest bearing debt implies that the firm has sufficient cash to pay its current liabilities whereas the company which has the interest bearing note faces the problem in paying its current liabilities.
3 Risk for investors is very low thereby making it attractive for the stockholders and interest bearing note makes it less attractive for the investors.

The company should decide to take on zero interest bearing note due to the following reasons;

1 When a company has no interest-bearing debt, the firm is very stable

2 No interest bearing debt implies that the firm has sufficient cash to pay its current liabilities.

3 It also shows that there will be no need for financing for taking the long term projects.

4 The firm does not have to pay any finance charge. Therefore, it makes it easier to calculate the net Income.
5 Risk for investors is very low thereby making it attractive for the stockholders

Noninterest-bearing note or a zero-interest -bearing note is recorded at the present value of the note and not at the face value of the note in the financial statements whereas short term interest bearing note is recorded as current liability in the financial statements and the interest expense will be shown in Income statement.