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Salem Co.has outstanding $100 million of 7% bonds,due in 7 years,and callable at 104.The bonds were issued at par and are selling today at a market price of 94.
-If Salem Co.calls $10 million of these bonds it will report:
A)A $700,000 gain.
B)A $400,000 loss.
C)A $600,000 gain.
D)Neither gains nor losses are recognized on early retirements of debt.

Question

Quizplus · Accepted Answer

If Salem Co. calls $10 million of these bonds, they will have to pay $10,400,000 (10 million x 104%) to retire the debt. However, since the bonds are currently selling at a discount, Salem Co. will only receive $9,400,000 (10 million x 94%) from investors. This will result in a loss of $1,000,000. Therefore, the correct answer is B) a $400,000 loss.

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