Professional Documents
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ANSWERS TO QUESTIONS
1. A company might choose to issue bonds instead of stock to avoid diluting
shareholders’ interests, to benefit from the tax deductions associated with paying
interest, and to potentially increase the return to shareholders.
2. A bond is a liability that is issued to the investing public to raise capital. Bonds are
traded on established exchanges, such as the New York Bond Exchange. When a
company issues bonds, it receives money from investors. Investors pay for the
bonds in order to earn interest over the life of the bond. At the end of a bond’s life,
investors receive the bond principle amount back from the company.
3. Unsecured bonds are not backed by any type of asset as a guarantee of repayment
at maturity. Secured bonds are backed by specific assets as a guarantee of
repayment at maturity.
4. A bond indenture is a legal document that specifies all the details of a bond
offering. A prospectus is a regulatory document filed with the Security and
Exchange Commission. It also provides details of the bond offering. A bond
indenture and a bond prospectus provide similar information.
5. Bond covenants are designed to protect bond investors but limiting what a
company can do while the bond is still outstanding.
7. The difference between a bond’s coupon rate and the market rate of interest
determines whether a bond is issued at a discount or a premium. When the coupon
rate is lower than the market rate of interest, the bond is issued at a discount.
When the coupon rate is higher than the market rate of interest, the bond is issued
at a premium.
8. The market interest rate reflects the return investor demand to invest in a security
with a given level of risk, so it is the rate used to discount a bond’s future cash
flows when calculating a bond’s present value.
9. The book value of a bond is the bond’s principle amount plus any premium or
minus any discount. A bond’s book value is what a company reports on its balance
sheet.
10. The formula used to calculate the cash payment bond investors receive for interest
each period is: principle amount x coupon rate. The formula used to calculate
interest expense reported each period is: book value of the bond at the beginning
of the period x the market rate of interest on the date of issuance.
11. The debt-to-equity ratio is calculated by dividing total liabilities by total stockholders’
equity. The ratio describes the relationship between the amount of capital provided
by owners and the amount of capital provided by creditors.
12. When market interest rates increase, bond prices decrease. This concept is easily
understood by remembering that the market rate of interest is the discount rate
used to calculate the present value of a bond’s future cash flows. The higher the
discount rate the lower the present value of the bond.
1. c) 2. c) 3. b) 4. d) 5. c)
6. b) 7. c) 8. c) 9. a) 10. c)
* Due to the nature of this project, it is very difficult to estimate the amount of time
students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While
students often benefit from the extra effort, we find that some become frustrated by the
perceived difficulty of the task. You can reduce student frustration and anxiety by
making your expectations clear. For example, when our goal is to sharpen research
skills, we devote class time to discussing research strategies. When we want the
students to focus on a real accounting issue, we offer suggestions about possible
companies or industries.
M10–2.
M10–3.
The times interest earned ratio is a better indicator. The debt-to-equity ratio
assesses how much debt relative to equity a company has in its capital structure.
It is considered a broad measure of risk sense a heavy reliance on debt financing
increases the risk that a company may not be able to meet its contractual
financial obligations. A ratio that gets at a company’s ability to meet a very
specific financial obligation is the times interest earned ratio. It attempts to
assess whether a company is generating sufficient resources from its profit-
making activities to meet its current interest obligations.
M10–4.
M10–6.
January 1:
Cash (+A) .............................................................................. 940,000
Bond discount (+XL, -L) ........................................................ 60,000
Bonds Payable (+L) .......................................................... 1,000,000
June 30:
Interest Expense (+E, -SE) ($940,000 .11 1/2) .............. 51,700
Bond discount (-XL, +L) .................................................... 1,700
Cash (-A) ($1,000,000 .10 1/2) ................................... 50,000
M10–7.
January 1:
Cash (+A) .............................................................................. 940,000
Bonds Payable (+L) .......................................................... 940,000
June 30:
Interest Expense (+E, -SE) ($940,000 .11 1/2) .............. 51,700
Bonds Payable (+L)........................................................... 1,700
Cash (-A) ($1,000,000 .10 1/2) ................................... 50,000
M10–9
January 1:
Cash (+A) .............................................................................. 910,000
Bond premium (+L) ........................................................... 60,000
Bonds Payable (+L) .......................................................... 850,000
December 31:
Interest Expense (+E, -SE) ($910,000 .07) ........................ 63,700
Bond premium (-L) ................................................................ 4,300
Cash (-A) ($850,000 .08) ................................................ 68,000
M10–10
January 1:
Cash (+A) .............................................................................. 910,000
Bonds Payable (+L) .......................................................... 910,000
December 31:
Interest Expense (+E, -SE) ($910,000 .07) ........................ 63,700
Bonds Payable (-L) ............................................................... 4,300
Cash (-A) ($850,000 .08) ................................................ 68,000
January 1:
Cash (+A) .............................................................................. 580,000
Bond discount (+XL, -L) ........................................................ 20,000
Bonds Payable (+L) ........................................................... 600,000
June 30:
Interest Expense (+E, -SE) ($30,000 + $1,000) .................... 31,000
Bond discount (-XL, +L) ($20,000 / 20) ............................. 1,000
Cash (-A) ($600,000 x .10 x ½) ......................................... 30,000
M10–12.
January 1:
Cash (+A) .............................................................................. 580,000
Bonds Payable (+L) ........................................................... 580,000
June 30:
Interest Expense (+E, -SE) ($30,000 + $1,000) .................... 31,000
Bonds Payable (+L) ($20,000 / 20) ................................... 1,000
Cash (-A) ($600,000 x .10 x ½) ......................................... 30,000
M10–13.
If market interest rates fall after the issuance of a bond, the bond’s price will
increase. This is because the market interest rate is used to discount the bond’s
future cash flows to determine its price, and a lower discount rate means a higher
present value (price). The company will report a loss on the debt retirement
because it will have to pay more to investors to retire the bonds than the bond’s
book value. On the balance sheet, cash and bonds payable will decrease. On
the income statement, a loss would be recorded for the difference between the
cash paid and the bond’s book value.
M10–14.
Cash paid for principle when a bond matures would be reported in the financing
section of the Statement of Cash Flows, while cash paid for interest would be
reported in the operating section.
E10–1.
Investors care about knowing the coupon rate because it determines the cash interest
payment they will receive each period. Investors care about knowing the yield because
it reflects the return they can expect if they invest in the bonds, and is the market
interest rate they would use to discount the bonds to determine its price. A decrease in
the yield after the bonds have initially been issued does not affect Apple’s financial
statements.
E10–2.
If interest rates were to fall, companies might decide to call their bonds and issue
new ones at a lower interest rate. When this is the case, a zero coupon bond offers
an extra margin of protection. A zero coupon bond is sold at a deep discount (say
60% of par). It would be very unusual to see a company call such a bond if it were
callable at par.
E10–3.
CASE A:
$100,000 x 0.58349 ...................................................... $ 58,349
$8,000* x 5.20637 ........................................................ 41,651
Issue price (market and stated rate same) ................... $100,000
*$100,000 x .08
CASE B:
$100,000 x 0.66506 ...................................................... $ 66,506
$8,000* x 5.58238 ........................................................ 44,659
Issue price (market rate less than stated rate).............. $111,165 (at a premium)
*$100,000 x .08
CASE C:
$100,000 x 0.54703 ...................................................... $ 54,703
$8,000* x 5.03295 ........................................................ 40,264
Issue price (market rate more than stated rate) ............ $ 94,967 (at a discount)
*$100,000 x .08
CASE A:
$500,000 x 0.67297 ...................................................... $ 336,485
$15,000* x 16.35143 .................................................... 245,271
Issue price (market rate less than coupon rate)............ $581,756 **(at a premium)
*$500,000 x .06 x ½
CASE B:
$500,000 x 0.55368 ...................................................... $ 276,840
$15,000* x 14.87747 .................................................... 223,162
Issue price (market rate same as coupon rate) ............ $500,002 (at par)
*$500,000 x .06 x 1/2
CASE C:
$500,000 x 0.43499 ...................................................... $ 217,495
$15,000* x 13.29437 .................................................... 199,416
Issue price (market rate greater than coupon rate)....... $ 416,911 (at a discount)
*$500,000 x .06 x 1/2
E10–5.
Req. 1
Req. 2
When Denver recognized interest expense, it decreased net income and decreased
cash. Since the balance in the bond payable account did not change, this means
that liabilities stay the same and equity decreased (as a result of the interest
expense). This will also increase the debt-to-equity ratio.
Financial Accounting, 9/e 10-9
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E10–6.
E10–7.
Present value:
$250,000 x 0.67556 = 168,890
$ 7,500* x 8.11090 = 60,832
Issue price = $229,722**
E10–8.
Present value:
$600,000 x 0.71679 = 430,074
$ 22,500* x 6.66378 = 149,935
Issue price = $580,009
Req. 1
January 1:
Cash (+A) .............................................................................. 580,009
Bond discount (+XL, -L) ........................................................ 19,991
Bonds Payable (+L) ........................................................... 600,000
Req. 2
June 30:
Interest Expense* (+E, -SE) ................................................. 24,650
Bond discount (-XL, +L) .................................................... 2,150
Cash (-A) ........................................................................... 22,500
*($580,009 x .085 x ½)
Req. 3
June 30:
Balance sheet:
Long-term Liabilities
Bonds payable $582,159*
*This is the book value of the bond payable. It is computed in one of two ways: (1)
By subtracting the unamortized discount ($19,991 - $2,150) from the face value of the
bonds ($600,000), or (2) by adding the amount of the discount amortized on June 30
($2,150) to the book value of the bond at the beginning of the period ($580,009).
E10–9.
Present value:
$600,000 x 0.71679 = 430,074
$ 22,500* x 6.66378 = 149,935
Issue price = $580,009
Req. 1
January 1:
Cash (+A) .............................................................................. 580,009
Bonds Payable (+L) ........................................................... 580,009
Req. 2
June 30:
Interest Expense* (+E, -SE) ................................................. 24,650
Bonds Payable (+L)........................................................... 2,150
Cash (-A) ........................................................................... 22,500
*($580,009 x .085 x ½)
Req. 3
June 30:
Balance sheet:
Long-term Liabilities
Bonds payable $582,159*
*This is the book value of the bond payable. It is computed by adding the amount of the
discount amortized on June 30 ($2,150) to the book value of the bond at the beginning
of the period ($580,009).
E10–10.
Req. 1
Cash Discount Book Value
Date Interest Interest Expense Amortization of Bond
Jan. 1, Yr 1 $97,327
Dec. 31, Yr 1 $5,000* $97,327 x .06 = $5,840 $840 98,167
Dec. 31, Yr 2 5,000 98,167 x .06 = $5,890 890 99,057
Dec. 31, Yr 3 5,000 99,057 x .06 = $5,943 943 100,00
*$100,000 x .05
Req. 2
Year 1 Year 2
December 31:
Interest expense................... $5,840 $5,890
Bond liability…………………. $98,167 $99,057
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E10–11.
1. The bond issue price was $948. This is given in the amortization table. It can also
be computed by taking the present value of the future cash flows and discounting
them by the market interest rate of 8 percent.
2. The bond sold at a discount. The amount of the discount was $52 ($1,000 – $948)
3. Balance sheet:
Year 1: $ 964 ($948 + $16)
Year 2: $ 981 ($964 + $17)
E10–12.
American specifies the coupon rate for the bonds, which determines the cash
payment made to investors each period for interest. American does not get to
specify the effective (market) interest rate. It is determined by market forces and
not the company. The market rate of interest continually changes as the result of
such factors as inflation expectations and the level of business activity.
E10–13.
Present value:
$2,000,000 x 0.43499 = 869,980
$ 100,000* x 13.29437 = 1,329,437
Issue price = $2,199,417
Req. 1
January 1:
Cash (+A) .............................................................................. 2,199,417
Bonds premium (+L).......................................................... 199,417
Bonds Payable (+L) .......................................................... 2,000,000
Req. 2
June 30:
Interest Expense (+E, -SE) ($2,199,417 x .0425) ................ 93,475
Bond premium (-L) ................................................................ 6,525
Cash (-A) ($2,000,000 x .10 x ½) ...................................... 100,000
Req. 3
Balance sheet:
Long-term Liabilities
Bonds payable $2,192,892*
*This is the book value of the bond payable. It is computed in one of two ways: (1)
By adding the unamortized premium ($199,417 - $6,525) to the face value of the bonds
($2,000,000), or (2) by subtracting the amount of the premium amortized on June 30
($6,525) from the book value of the bond at the beginning of the period ($2,199,417).
Req. 1
January 1:
Cash (+A) .............................................................................. 2,199,417
Bonds Payable (+L) .......................................................... 2,199,417
Req. 2
June 30:
Interest Expense (+E, -SE) ($2,199,417 x .0425) ................ 93,475
Bonds Payable (-L) ............................................................... 6,525
Cash (-A) ($2,000,000 x .10 x ½) ...................................... 100,000
Req. 3
Balance sheet:
Long-term Liabilities
Bonds payable $2,192,892*
*This is the book value of the bond payable. It is computed by subtracting the amount of
the premium amortized on June 30 ($6,525) from the book value of the bond at the
beginning of the period ($2,199,417).
Req. 1
Cash Premium Book Value
Date Interest Interest Expense Amortization of Bond
Jan. 1, Yr 1 $10,278
Dec. 31, Yr 1 $500* $10,278 x .04 = $411 $89 10,189
Dec. 31, Yr 2 500 10,189 x .04 = $408 92 10,097
Dec. 31, Yr 3 500 10,097 x .04 = $404 96 10,001**
*$10,000 x .05
** $1 rounding error
Present value computation:
Principal: $10,000 x .88900 $ 8,890
Interest: 500 x 2.77509 1,388
Issue price $10,278
Req. 2
Year 1 Year 2
December 31:
Interest expense................... $411 $408
Bond liability…………………. $10,189 $10,097
E10–16.
Req. 1
Present value
$ 1,000,000 x .45639 = 456,390
$ 45,000* x 13.59033 = 611,565
$ 1,067,955**
January 1:
Cash (+A) .............................................................................. 1,067,955
Bonds payable (+L) ........................................................... 1,000,000
Bond premium (+L) ............................................................ 67,955
Req. 2
E10–17.
*$1,000,000 x (1 +.05)
E10–18.
*$1,000,000 x (1 + .05)
E10–19.
*$1,000,000 x (1 + .05)
*$750,000 x .08
Req. 1
January 1:
Cash (+A) .............................................................................. 701,868
Bond discount (+XL, -L) ........................................................ 48,132
Bonds Payable (+L) ........................................................... 750,000
Req. 2
December 31:
Interest Expense (+E, -SE) ................................................... 64,813
Bond discount (-XL, +L) ($48,132 / 10) ............................. 4,813
Cash (-A) ........................................................................... 60,000
Req. 3
December:
Balance sheet:
Long-term Liabilities
Bonds payable $706,681*
*This is the book value of the bond payable. It is computed in one of two ways: (1)
By subtracting the unamortized discount ($48,132 - $4,813) from the face value of the
bonds ($750,000), or (2) by adding the amount of the discount amortized on December
31 ($4,813) to the book value of the bond at the beginning of the period ($701,868).
*$750,000 x .08
Req. 1
January 1:
Cash (+A) .............................................................................. 701,868
Bonds Payable (+L) ........................................................... 701,868
Req. 2
December 31:
Interest Expense (+E, -SE) ................................................... 64,813
Bonds Payable (+L) (($750,000 - $701,868) / 10) ............. 4,813
Cash (-A) ........................................................................... 60,000
Req. 3
December 31:
Balance sheet:
Long-term Liabilities
Bonds payable $706,681*
*This is the book value of the bond payable. It is computed by adding the amount of the
discount amortized on December 31 ($4,813) to the book value of the bond at the
beginning of the period ($701,868).
Req. 1
January 1:
Cash (+A) .............................................................................. 1,498,277
Bond premium (+L) ........................................................... 98,277
Bonds Payable (+L) .......................................................... 1,400,000
Req. 2
June 30:
Interest Expense (+E, -SE) ................................................... 43,715
Bonds premium (-L) ($98,277 / 8) ......................................... 12,285
Cash (-A) ........................................................................... 56,000
Req. 3
June 30
Balance sheet:
Long-term Liabilities
Bonds payable $1,485,992*
*This is the book value of the bond payable. It is computed in one of two ways: (1)
By adding the unamortized premium ($98,277 - $12,285) to the face value of the bonds
($1,400,000), or (2) by subtracting the amount of the premium amortized on June 30
($12,285) from the book value of the bond at the beginning of the period ($1,498,277).
Req. 1
January 1:
Cash (+A) .............................................................................. 1,498,277
Bonds Payable (+L) .......................................................... 1,498,277
Req. 2
June 30:
Interest Expense (+E, -SE) ................................................... 43,715
Bonds Payable (-L) (($1,498,277 - $1,400,000 / 8) ............... 12,285
Cash (-A) ........................................................................... 56,000
Req. 3
June 30
Balance sheet:
Long-term Liabilities
Bonds payable $1,485,992*
*This is the book value of the bond payable. It is computed by subtracting the amount of
the premium amortized on June 30 ($12,285) from the book value of the bond at the
beginning of the period ($1,498,277).
2. Transaction does not involve cash so there is no effect on the Statement of Cash
Flows.
P10–1.
Req. 1
Req. 2
Req. 3
Req. 4
It is important to note that the above calculations assume that Arbor’s other liability and
equity accounts do not change, and that we are only adding additional debt or equity to
its balance sheet. Since we do not have additional information this is a fair assumption,
but it is not likely to be the case. For example, Arbor may earn a substantial amount of
net income during the year, which would reduce its debt-to-equity ratio in both
calculations above.
Relying just on the ratios computed above, it appears that issuing additional debt to
fund the project would be risky since it will put Arbor right on the edge of violating its
debt covenant. Typically when a company violates its debt covenants, it is required to
expedite the repayment of any debt governed by the covenant. This would be costly to
Arbor. As a result, the safest alternative is likely to be choosing to fund the project by
issuing additional equity.
Req. 1
Present value
$ 100,000 x .67556 = 67,556
$ 4,000* x 8.11090 = 32,444
Issue price $100,000
Req. 2
June 30 Dec. 31
Interest expense ($100,000 x .08 x 1/2) . $4,000 $4,000
Req. 3
June 30 Dec. 31
Cash owed ($100,000 x .08 x 1/2) ......... $4,000 $4,000
Req. 4
P10–3.
CASE A
a. Cash received at issuance (Case A): Market interest 7%
Present value:
$500,000 x 0.50835 = 254,175
$ 35,000* x 7.02358 = 245,825
Issue price = $500,000**
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*$500,000 x .07
CASE B
Present value:
$500,000 x 0.46319 = 231,595
$ 35,000* x 6.71008 = 234,853
Issue price = $466,448**
*$500,000 x .07
CASE C
Present value:
$500,000 x 0.55839 = 279,195
$ 35,000* x 7.36009 = 257,603
Issue price = $536,798**
*$500,000 x .07
P10–4.
CASE A:
$800,000 x 0.73069 ...................................................... $ 584,552
$32,000* x 6.73274 ...................................................... 215,448
Issue price (market rate same as coupon rate) ............ $800,000 (at par)**
*$800,000 x .08 x ½
CASE B:
$800,000 x 0.78941 ...................................................... $ 631,528
$32,000* x 7.01969 ...................................................... 224,630
Issue price (market rate less than coupon) ................... $856,158 (at a premium)**
P10–5.
1. Issuance price:
Present value:
$200,000 x 0.46319 = 92,638
$ 12,000* x 6.71008 = 80,521
Issue price = $173,159**
*$200,000 x .06
3.
The times interest earned ratio decreases because interest expense is tax deductible,
which reduces the numerator, and the increase in interest expense increases the
denominator…both of which decrease the ratio.
Req. 1
Issuance price:
Present value:
$1,000,000 x 0.31180 = 311,800
$ 50,000* x 11.4699 = 573,495
Issue price = $885,295**
Req. 2
June 30 December 31
Interest expense..................................... $53,118* $53,305**
Req. 3
June 30 December 31
Cash paid ($1,000,000 x .10 x ½) .......... $50,000 $50,000
Req. 4
June 30 December
31
Bonds payable ....................................... $888,4134* $891,718**
Req. 1
January 1:
Cash (+A) .............................................................................. 92,980
Bonds discount (+XL, -L)....................................................... 7,020
Bonds Payable (+L) ........................................................... 100,000
Req. 2
March 31:
Interest Expense (+E, -SE) ($92,980 x .12 x ¼) ................... 2,789
Bond discount (-XL, +L) .................................................... 789
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
June 30:
Interest Expense (+E, -SE) ($93,769 x .12 x ¼) ................... 2,813
Bond discount (-XL, +L) .................................................... 813
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
September 31:
Interest Expense (+E, -SE) ($94,582 x .12 x ¼) ................... 2,837
Bond discount (-XL, +L) .................................................... 837
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
December 31:
Interest Expense (+E, -SE) ($95,419 x .12 x ¼) ................... 2,863
Bond discount (-XL, +L) ....................................................... 863
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
Book value of bond: $96,282 ($100,000 – ($7,020 - $789 – $813 - $837 - $863))
Req. 3
December 31:
Balance sheet:
Long-term Liabilities
Bonds payable $96,282
P10–8.
Present value:
$100,000 x 0.78941 = 78,941
$ 2,000* x 7.01969 = 14,039
Issue price = $92,980
Req. 1
January 1:
Cash (+A) .............................................................................. 92,980
Bonds Payable (+L) ........................................................... 92,980
Req. 2
March 31:
Interest Expense (+E, -SE) ($92,980 x .12 x ¼) ................... 2,789
Bonds Payable (+L)........................................................... 789
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
June 30:
Interest Expense (+E, -SE) ($93,769 x .12 x ¼) ................... 2,813
Bonds Payable (+L)........................................................... 813
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
September 31:
Interest Expense (+E, -SE) ($94,582 x .12 x ¼) ................... 2,837
Bonds Payable (+L)........................................................... 837
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
December 31:
Interest Expense (+E, -SE) ($95,419 x .12 x ¼) ................... 2,863
Bonds Payable (+L)........................................................... 863
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
Req. 3
December 31:
Balance sheet:
Long-term Liabilities
Bonds payable $96,282
Req. 1
Issuance price:
Present value
$700,000 x 0.31180 = 218,260
$ 45,500* x 11.46992 = 521,881
Issue price = $740,141**
Req. 2
June 30 December 31
Interest expense..................................... $44,408* $44,343**
Req. 3
June 30 December 31
Cash paid ............................................... $45,500 $45,500
Req. 4
June 30 December 31
Bonds payable ....................................... $723,802* $721,730**
Calculations:
Annual market interest rate at time of issuance: $3,417 $48,813 = 7%
Coupon rate: $48,000 / $3,600 = 7.5%
Interest: 7% x Previous balance
Cash payment: 7.5% x $48,000
Amortization: Cash payment – Interest
Balance: Previous balance – Amortization
2. Principle amount: $48,000 from last column at end of the last year.
Req. 1
January 1:
Cash ...................................................................................... 321,976
Bond premium (+L) ........................................................... 21,976
Bond payable (+L) ............................................................. 300,000
Req. 2
March 31:
Interest Expense (+E, -SE) ($321,976 x .02) ....................... 6,440
Bond premium (-L) ................................................................ 2,560
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
June 30:
Interest Expense (+E, -SE) ($319,416 x .02) ....................... 6,388
Bond premium (-L) ................................................................ 2,612
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
September 31:
Interest Expense (+E, -SE) ($316,804 x .02) ....................... 6,336
Bond premium (-L) ................................................................ 2,664
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
December 31:
Interest Expense (+E, -SE) ($314,140 x .02) ....................... 6,283
Bond premium (-L) ................................................................ 2,717
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
Req. 3
December 31:
Balance sheet:
Long-term Liabilities
Bonds payable $311,423
P10–12.
Present value:
$300,000 x 0.85349 = 256,047
$ 9,000* x 7.32548 = 65,929
Issue price = $321,976
Req. 1
January 1:
Cash ...................................................................................... 321,976
Bond payable (+L) ............................................................. 321,976
Req. 2
March 31:
Interest Expense (+E, -SE) ($321,976 x .02) ....................... 6,440
Bonds Payable (-L) ............................................................... 2,560
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
June 30:
Interest Expense (+E, -SE) ($319,416 x .02) ....................... 6,388
Bonds Payable (-L) ............................................................... 2,612
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
December 31:
Interest Expense (+E, -SE) ($314,140 x .02) ....................... 6,283
Bonds Payable (-L) ............................................................... 2,717
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
Req. 3
December 31:
Balance sheet:
Long-term Liabilities
Bonds payable $311,423
P10–13.
*$1,000,000 x (1 + .05)
P10–14.
*$1,000,000 x (1 + .05)
Req. 1
Present value:
$800,000 x 0.56743 = 453,944
$ 64,000* x 3.60478 = 230,706
Issue price = $684,650
*$800,000 x .08
*Calculated interest is $92,572. We use $92,567 in the table to bring the bond payable
balance to exactly $800,000 at the end of Year 5. If we had started our amortization
table with $684,647 and used Excel or a financial calculator to derive interest
expense we would not need to round any of the numbers.
Req. 1
Present value
$ 2,000,000 x .61391 = 1,227,820
$ 100,000* x 7.72173 = 772,173
Issue price $1,999,993**
**If the tables carried the decimal out further the issue price would be $2,000,000.
Using Excel or a financial calculator results in a present value of $2,000,000.
Req. 2
June 30 Dec. 31
Interest expense ($2,000,000 x .10 x ½) $100,000 $100,000
Req. 3
June 30 Dec. 31
Cash paid($2,000,000 x .10 x ½) ........... $100,000 $100,000
Req. 4
Req. 1
Present value
$ 2,000,000 x 0.71299 = 1,425,980
$ 120,000* x 4.10020 = 492,024
Issue Price $1,918,004**
*$2,000,000 x .06
Req. 2
Req. 3
Req. 4
*$4,000,000 x .09
Req. 2
Req. 3
Req. 4
Req. 1
January 1:
Cash ...................................................................................... 207,799
Bond premium (+L) ........................................................... 7,799
Bond payable (+L) ............................................................. 200,000
Req. 2
June 30:
Interest Expense (+E, -SE) ($207,799 x .085 x 1/2) ............. 8,831
Bond premium (-L) ................................................................ 1,169
Cash (-A) ($200,000 x .10 x 1/2) ....................................... 10,000
December 31:
Interest Expense (+E, -SE) ($206,630 x .085 x 1/2) ............. 8,782
Bond premium (-L) ................................................................ 1,218
Cash (-A) ($200,000 x .10 x 1/2) ....................................... 10,000
Req. 3
December 31:
Balance sheet:
Long-term Liabilities
Bonds payable $205,412
Req. 1
January 1:
Cash ...................................................................................... 207,799
Bonds Payable (+L)........................................................... 7,799
Bond payable (+L) ............................................................. 200,000
Req. 2
June 30:
Interest Expense (+E, -SE) ($207,799 x .085 x 1/2) ............. 8,831
Bonds Payable (-L) ............................................................... 1,169
Cash (-A) ($200,000 x .10 x 1/2) ....................................... 10,000
December 31:
Interest Expense (+E, -SE) ($206,630 x .085 x 1/2) ............. 8,782
Bonds Payable (-L) ............................................................... 1,218
Cash (-A) ($200,000 x .10 x 1/2) ....................................... 10,000
Req. 3
December 31:
Balance sheet:
Long-term Liabilities
Bonds payable $205,412
CONTINUING CASE
CON10–1.
Req. 1
Present value
$750,000,000 x .67297 = 504,727,500
$ 18,750,000* x 16.35143 = 306,589,313
Issue price $811,316,813**
Req. 2
June 30 Dec. 31
This Year This Year
Interest expense.....................................$16,226,336* $16,175,863**
Req. 3
June 30 Dec. 31
This Year This Year
Cash paid ...............................................$18,750,000* $18,750,000*
Req. 4
June 30 Dec. 31
This Year This Year
Book value of bonds...............................
$808,793,149* $806,219,012**
CP10–1.
Req. 1
Near the end of footnote 2, American Eagle reports paying interest of $638,000.
Req. 2
Footnote 9 describes the company’s “Credit Agreement.” Under the agreement, the
company can borrow up to $400 million.
CP10–2.
Req. 1
The company would report the amount of cash paid for interest in its cash flow
statement or in its footnotes.
Req. 2
Footnote 7 describes the company’s “Line of Credit.” Under the agreement, the
company can currently borrow up to $175 million, though the agreement has an
accordion feature that allows Urban Outfitters to increase this amount in the future.
Req. 1
The three ratios are quite similar. American Eagle’s debt-to-equity ratio is 0.49. Urban
Outfitters’ debt-to-equity ratio is 0.42. The industry average debt-to-equity ratio is 0.43.
Req. 2
Neither American Eagle or Urban Outfitters have issued bonds, nor does either firm
have much long-term debt. This indicates that the debt-to-equity ratio may be of limited
use when analyzing the firms. At a minimum, analysts should keep this in mind when
analyzing the two firms and comparing them to the industry average.
CP10–4.
Req. 1
A zero coupon bond simply means that no periodic interest payments will be made over
the bond’s life. It does not mean that investors will not earn interest. Investors will simply
adjust the price they are willing to pay for the bond until it reflects a return over the life of
the bond that is equal to the market rate of interest. Thus, with a zero coupon bond,
investors do not get periodic interest payments, but they do earn interest. The just have
to wait until the bond matures, at which time they get all of the interest they have earned
plus the principle they contributed.
Req. 2
Req. 3
CP10–5.
CP10–6.
As with most difficult decisions that people face, this dilemma does not have an
obvious right answer. We have found that some students approach this question
from the perspective that people’s jobs are more important than people’s money.
We try to point out that both the current workers and the retired investors are
dependent on income from the corporation in order to survive. Nevertheless,
some students will not budge from the belief that workers have a higher priority
than suppliers of capital. Once this part of the discussion winds down, we like to
shift to the issues of fiduciary responsibility. Even if students believe that the
needs of the workers should take priority, a question remains concerning the
portfolio manager’s professional obligation. Given that he has been hired to
protect the interests of the investors, how high a priority can be placed on
another group that will be affected by a potential bankruptcy?
CP10–7.
The response to this case will depend on the companies selected by the
students.