Financial and Managerial Accounting Study Set 1

Business

Quiz 12 :

Long-Term Liabilities: Bonds and Notes

Quiz 12 :

Long-Term Liabilities: Bonds and Notes

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Effect of financing on earnings per share Three different plans for financing an $80,000,000 corporation are under consideration by its organizers. Under each of the following plans, the securities will be issued at their par or face amount, and the income tax rate is estimated at 40% of income: img Instructions 1. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $10,000,000. 2. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $6,000,000. 3. Discuss the advantages and disadvantages of each plan.
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1. Effect of financing on EPS: (Amount in $) img 2. Effect of financing on EPS
(Amount in $) img 3. Advantages and disadvantages: When the company is earning good profits then, plan 3 is good for the shareholders. EPS is a more in the plan 3, when the EBIT is $10,000,000. But when the EBIT is 6,000,000, plan 3 generates only $0.44 and plan 2, generates $1.80. Keeping in mind the earnings capacity of the company, a proper financial plan should be implemented.

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A corporation issues $26,000,000 of 9% bonds to yield interest at the rate of 7%. (a) Was the amount of cash received from the sale of the bonds greater or less than $26,000,000? (b) Identify the following amounts as they relate to the bond issue: (1) face amount, (2) market or effective rate of interest, (3) contract rate of interest, and (4) maturity amount.
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Bonds Payable:
A bond is a long-term debt security. Bonds are issued with specific coupon or nominal rate, which is determined largely by market conditions at the time of the bond issuance. The amount of the interest payment can be calculated by multiplying the rate of interest (or coupon) by the face value.
Often, bonds are issued at interest rate which is equal to prevailing market rate. But, in few instances it differs. If the issued interest rate is higher than the market rate then it is a case of premium vice versa if they are issued at interest rate lower than the market rate it is a case of discount. Depending on the nature of issue say premium or discount, amount will be amortized through-out the life of the bond like an expense or income.
a. In the present case, the issued interest rate is more than the market interest rate then, the bonds are issued at premium. It means the cash received on issuance of bonds is more than the face value of the bonds payable.
Thus, the amount of cash received more than $ 26,000,000.
b. (1)Face value of the bonds is
img .
(2)Market or effective rate of interest is
img .
(3)Contract rate of interest is
img .
(4)Maturity amount is
img .

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Bond premium, entries for bonds payable transactions Rodgers Corporation produces and sells football equipment. On July 1, Year 1, Rodgers Corporation issued $65,000,000 of 10-year, 12% bonds at a market (effective) interest rate of 10%, receiving cash of $73,100,469. Interest on the bonds is payable semiannually on December 31 and June 30. The fiscal year of the company is the calendar year. Instructions 1. Journalize the entry to record the amount of cash proceeds from the issuance of the bonds on July 1, Year 1. 2. Journalize the entries to record the following: a. The first semiannual interest payment on December 31, Year 1, and the amortization of the bond premium, using the straight-line method. Round to the nearest dollar. b. The interest payment on June 30, Year 2, and the amortization of the bond premium, using the straight-line method. Round to the nearest dollar. 3. Determine the total interest expense for Year 1. 4. Will the bond proceeds always be greater than the face amount of the bonds when the contract rate is greater than the market rate of interest? 5. (Appendix 1) Compute the price of $73,100,469 received for the bonds by using the present value tables in Appendix A at the end of the text. Round to the nearest dollar.
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Entries for bonds payable transactions at premium
1. img Working Notes
Present Value of bonds at effective (market) rate of interest of 10% 73,100,469
Face Value of bonds at 12%, 10 year bonds 65,000,000
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8,100,469
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2a. img Working Notes:
img img 2b. img Working Notes:
img img 3. img '=
4. Yes the bond proceeds will always be greater than the face amount of the bonds when the contract rate is greater than the market rate of interest.
5.
img PV of bond's interest payments
img img img img img img img img img Note - Difference on account of rounding off

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If you asked your broker to buy you a 12% bond when the market interest rate for such bonds was 11%, would you expect to pay more or less than the face amount for the bond? Explain.
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Evaluate alternative financing plans Based on the data in Exercise 14-1, what factors other than earnings per share should be considered in evaluating these alternative financing plans?
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A ? Issuing bonds at a discount On the first day of the fiscal year, a company issues a $1,200,000, 9%, five-year bond that pays semiannual interest of $54,000 ($1,200,000 × 9% × ½), receiving cash of $1,153,670. Journalize the bond issuance. B ? Issuing bonds at a discount On the first day of the fiscal year, a company issues a $3,000,000, 11%, five-year bond that pays semiannual interest of $165,000 ($3,000,000 × 11% × ½), receiving cash of $2,889,599. Journalize the bond issuance.
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Bond discount, entries for bonds payable transactions On July 1, 2016, Merideth Industries Inc. issued $28,500,000 of 10-year, 8% bonds at a market (effective) interest rate of 9%, receiving cash of $26,646,292. Interest on the bonds is payable semiannually on December 31 and June 30. The fiscal year of the company is the calendar year. Instructions 1. Journalize the entry to record the amount of cash proceeds from the issuance of the bonds on July 1, 2016. 2. Journalize the entries to record the following: a. The first semiannual interest payment on December 31, 2016, and the amortization of the bond discount, using the straight-line method. (Round to the nearest dollar.) b. The interest payment on June 30, 2017, and the amortization of the bond discount, using the straight-line method. (Round to the nearest dollar.) 3. Determine the total interest expense for 2016. 4. Will the bond proceeds always be less than the face amount of the bonds when the contract rate is less than the market rate of interest? 5. (Appendix 1) Compute the price of $26,646,292 received for the bonds by using the present value tables in Appendix A at the end of the text. (Round to the nearest dollar.)
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General Electric bond issuance General Electric Capital, a division of General Electric, uses long-term debt extensively. In a recent year, GE Capital issued $11 billion in long-term debt to investors, then within days filed legal documents to prepare for another $50 billion long-term debt issue. As a result of the $50 billion filing, the price of the initial $11 billion offering declined (due to higher risk of more debt). Bill Gross, a manager of a bond investment fund, "denounced a 'lack in candor' related to GE's recent debt deal. 'It was the most recent and most egregious example of how bondholders are mistreated.' Gross argued that GE was not forthright when GE Capital recently issued $ 11 billion in bonds, one of the largest issues ever from a U.S. corporation. What bothered Gross is that three days after the issue the company announced its intention to sell as much as $50 billion in additional debt, warrants, preferred stock, guarantees, letters of credit and promissory notes at some future date." In your opinion, did GE Capital act unethically by selling $11 billion of long-term debt without telling those investors that a few days later it would be filing documents to prepare for another $50 billion debt offering? Source: Jennifer Ablan, "Gross Shakes the Bond Market; GE Calms It, a Bit," Barron's, March 25, 2002.
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Explain the meaning of each of the following terms as they relate to a bond issue: (a) convertible and (b) callable.
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Describe the two distinct obligations incurred by a corporation when issuing bonds.
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Bond premium, entries for bonds payable transactions Saverin Inc. produces and sells outdoor equipment. On July 1, 2016, Saverin Inc. issued $62,500,000 of 10-year, 9% bonds at a market (effective) interest rate of 8%, receiving cash of $66,747,178. Interest on the bonds is payable semiannually on December 31 and June 30. The fiscal year of the company is the calendar year. Instructions 1. Journalize the entry to record the amount of cash proceeds from the issuance of the bonds on July 1, 2016. 2. Journalize the entries to record the following: a. The first semiannual interest payment on December 31, 2016, and the amortization of the bond premium, using the straight-line method. (Round to the nearest dollar.) b. The interest payment on June 30, 2017, and the amortization of the bond premium, using the straight-line method. (Round to the nearest dollar.) 3. Determine the total interest expense for 2016. 4. Will the bond proceeds always be greater than the face amount of the bonds when the contract rate is greater than the market rate of interest? 5. (Appendix 1) Compute the price of 66,747,178 received for the bonds by using the present value tables in Appendix A at the end of the text. (Round to the nearest dollar.)
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Preferred stock vs. bonds Xentec Inc. has decided to expand its operations to owning and operating golf courses. The following is an excerpt from a conversation between the chief executive officer, Peter Kilgallon, and the vice president of finance, Dan Baron: img Discuss the advantages and disadvantages of issuing preferred stock versus bonds.
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A ? Issuing bonds at face amount On January 1, the first day of the fiscal year, a company issues a $500,000, 5%, 10-year bond that pays semiannual interest of $12,500 ($500,000 × 5% × ½ year), receiving cash of $500,000. Journalize the entries to record (a) the issuance of the bonds, (b) the first interest payment on June 30, and (c) the payment of the principal on the maturity date. B ? Issuing bonds at face amount On January 1, the first day of the fiscal year, a company issues a $800,000, 4%, 10-year bond that pays semiannual interest of $16,000 ($800,000 × 4% × ½ year), receiving cash of $800,000. Journalize the entries to record (a) the issuance of the bonds, (b) the first interest payment on June 30, and (c) the payment of the principal on the maturity date.
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Effect of financing on earnings per share Three different plans for financing an $18,000,000 corporation are under consideration by its organizers. Under each of the following plans, the securities will be issued at their par or face amount, and the income tax rate is estimated at 40% of income: img Instructions 1. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $2,100,000. 2. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $1,050,000. 3. Discuss the advantages and disadvantages of each plan.
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Corporate financing The financial statements for Nike, Inc. , are presented in Appendix B at the end of the text. What is the major source of financing for Nike?
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Ethics and professional conduct in business Solar Industries develops and produces high-efficiency solar panels. The company has an outstanding $10,000,000, 30-year, 10% bond issue dated July 1, 2011. The bond issue is due June 30, 2040. Some bond indentures require the corporation issuing the bonds to transfer cash to a special cash fund, called a sinking fund, over the life of the bond. Such funds help assure investors that there will be adequate cash to pay the bonds at their maturity date. The bond indenture requires a bond sinking fund, which has a balance of $1,200,000 as of July 1, 2016. The company is currently experiencing a shortage of funds due to a recent acquisition. Bob Lachgar, the company's treasurer, is considering using the funds from the bond sinking fund to cover payroll and other bills that are coming due at the end of the month. Bob's brother-in-law, a trustee of Solar's sinking fund, has indicated a willingness to allow Bob to use the funds from the sinking fund to temporarily meet the company's cash needs. Discuss whether Bob's proposal is appropriate.
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Bond discount, entries for bonds payable transactions On July 1, Year 1, Livingston Corporation, a wholesaler of manufacturing equipment, issued $46,000,000 of 20-year, 10% bonds at a market (effective) interest rate of 11%, receiving cash of $42,309,236. Interest on the bonds is payable semiannually on December 31 and June 30. The fiscal year of the company is the calendar year. Instructions 1. Journalize the entry to record the amount of cash proceeds from the issuance of the bonds on July 1, Year 1. 2. Journalize the entries to record the following: a. The first semiannual interest payment on December 31, Year 1, and the amortization of the bond discount, using the straight-line method. Round to the nearest dollar. b. The interest payment on June 30, Year 2, and the amortization of the bond discount, using the straight-line method. Round to the nearest dollar. 3. Determine the total interest expense for Year 1. 4. Will the bond proceeds always be less than the face amount of the bonds when the contract rate is less than the market rate of interest? 5. (Appendix 1) Compute the price of $42,309,236 received for the bonds by using the present value tables in Appendix A at the end of the text. Round to the nearest dollar.
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Present values Alex Kelton recently won the jackpot in the Colorado lottery while he was visiting his parents. When he arrived at the lottery office to collect his winnings, he was offered the following three payout options: a. Receive $100,000,000 in cash today. b. Receive $25,000,000 today and $9,000,000 per year for eight years, with the first payment being received one year from today. c. Receive $15,000,000 per year for 10 years, with the first payment being received one year from today. Assuming that the effective rate of interest is 7%, which payout option should Alex select? Use the present value tables in Appendix A. Explain your answer and provide any necessary supporting calculations.
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Effect of financing on earnings per share Domanico Co., which produces and sells biking equipment, is financed as follows: img Income tax is estimated at 40% of income. Determine the earnings per share of common stock, assuming that the income before bond interest and income tax is (a) $10,500,000, (b) $11,800,000, and (c) $13,000,000.
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A ? Alternative financing plans Owen Co. is considering the following alternative financing plans: img Income tax is estimated at 40% of income. Determine the earnings per share of common stock, assuming income before bond interest and income tax is $750,000. B ? Alternative financing plans Brower Co. is considering the following alternative financing plans: img Income tax is estimated at 40% of income. Determine the earnings per share of common stock, assuming income before bond interest and income tax is $2,000,000.
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