Solution manual accounting 21e by warreni ch 15

CHAPTER 15 BONDS PAYABLE AND INVESTMENTS IN BONDS CLASS DISCUSSION QUESTIONS (1) To pay the face (maturity) amount of the bonds at a specified date (2) To pay periodic interest at a specified percentage of the face amount a Bonds that may be exchanged for other securities under specified conditions b The issuing corporation reserves the right to redeem the bonds before the maturity date c Bonds issued on the basis of the general credit of the corporation The phrase “time value of money” means that an amount of cash to be received today is worth more than the same amount of cash to be received in the future This is because cash on hand today can be invested to earn income (b) $5,000 to be received at the end of each of the next two years has the higher present value because cash is received earlier than can be invested to earn income Less than face amount Because comparable investments in bonds provide a market interest rate (8%) that is greater than the rate on the bond being purchased (7%), the bond will sell at a discount as the market’s means of equalizing the two interest rates a Greater than $7,500,000 b $7,500,000 7% 8% $7,500,000 Less than the contract rate a Premium b $50,000 c Premium on Bonds Payable a Debit Interest Expense Credit Discount on Bonds Payable b Debit Premium on Bonds Payable Credit Interest Expense 10 No Because zero-coupon bonds not provide for interest payments, they will sell at a discount 11 The purpose of a bond sinking fund is to accumulate over the life of a bond issue enough funds to pay the indebtedness at the maturity date 12 The bond issue that is callable is more risky for investors, because the company may redeem (call) the bond issue if interest rates fall In addition, since the bonds may be called at their face amount, they will sell for a lower value than the noncallable bond issue 13 A loss of $8,500 [($800,000 × 0.97) – ($800,000 – $32,500)] 14 Under the caption “Investments” 15 At their cost less any amortized premium or plus any amortized discount 169 EXERCISES Ex 15–1 a Earnings before bond interest and income tax Bond interest Balance Income tax Net income Dividends on preferred stock Earnings available for common stock Bridger Co $ 1,600,000 640,000 $ 960,000 384,000 $ 576,000 480,000 $ 96,000 Earnings per share on common stock $ b Earnings before bond interest and income tax Bond interest Balance Income tax Net income Dividends on preferred stock Earnings available for common stock c 0.48 $ 2,400,000 640,000 $ 1,760,000 704,000 $ 1,056,000 480,000 $ 576,000 Earnings per share on common stock $ 2.88 Earnings before bond interest and income tax Bond interest Balance Income tax Net income Dividends on preferred stock Earnings available for common stock $ 4,000,000 640,000 $ 3,360,000 1,344,000 $ 2,016,000 480,000 $ 1,536,000 Earnings per share on common stock $ 7.68 Ex 15–2 Factors other than earnings per share that should be considered in evaluating financing plans include: bonds represent a fixed annual interest requirement, while dividends on stock not; bonds require the repayment of principal, while stock does not; and common stock represents a voting interest in the ownership of the corporation, while bonds not Ex 15–3 Home Depot’s major source of financing is common stock It has long-term debt, excluding current installments, of $1,321,000,000, compared to stockholders’ equity of $19,802,000,000 Ex 15–4 a $100,000 ÷ 1.05 = $95,238 $ 95,238 ÷ 1.05 = $90,703 $ 90,703 ữ 1.05 = $86,384 b $100,000 ì 0.86384 = $86,384 Ex 15–5 a First Year: $50,000 × 0.94340 = $ 47,170.00 Second Year: $50,000 × 0.89000 = 44,500.00 Third Year: $50,000 × 0.83962 = 41,981.00 Fourth Year: $50,000 × 0.79209 = 39,604.50 Total present value $173,255.50 b $50,000 × 3.46511 = $173,255.50 Ex 15–6 $1,000,000 × 12.78336 = $12,783,360 Ex 15–7 No The present value of your winnings using an interest rate of 12% is $7,843,140 ($1,000,000 × 7.84314), which is more than one-half of the present value of your winnings using an interest rate of 6% ($12,783,360; see Ex 15–6) This is because of the effect of compounding the interest That is, compound interest functions are not linear functions, but use exponents Ex 15–8 Present value of $1 for 10 (semiannual) periods at 6% (semiannual rate) Face amount of bonds Present value of an annuity of $1 for 10 periods at 6% Semiannual interest payment Total present value (proceeds) 0.55840 × $12,000,000 × 7.36009 $480,000 $ 6,700,800 3,532,843 $ 10,233,643 Ex 15–9 Present value of $1 for 10 (semiannual) periods at 5% (semiannual rate) Face amount of bonds Present value of an annuity of $1 for 10 periods at 5% Semiannual interest payment Total present value (proceeds) 0.61391 × $40,000,000 7.72174 × $2,200,000 $24,556,400 16,987,828 $41,544,228 Ex 15–10 The bonds were selling at a premium This is indicated by the selling price of 103.536, which is stated as a percentage of face amount and is more than par (100%) The market rate of interest for similar quality bonds was lower than 2.125%, and this is why the bonds were selling at a premium Ex 15–11 May Nov 1 Dec 31 Cash Bonds Payable 18,000,000 Interest Expense Cash 630,000 Interest Expense Interest Payable 210,000 18,000,000 630,000 210,000 Ex 15–12 a Cash Discount on Bonds Payable Bonds Payable 7,095,482 904,518 Interest Expense Cash 320,000 Interest Expense Cash 320,000 Interest Expense Discount on Bonds Payable $904,518 ÷ years = $180,904 180,904 8,000,000 320,000 320,000 180,904 b Annual interest paid Plus discount amortized Interest expense for first year $ 640,000 180,904 $ 820,904 Note: The following data in support of the proceeds of the bond issue stated in the exercise are presented for the instructor’s information Students are not required to make the computations Present value of $1 for 10 (semiannual) periods at 1/2% (semiannual rate) Face amount Present value of annuity of $1 for 10 periods at 1/2% Semiannual interest payment Total present value of bonds payable 0.58543 × $ 8,000,000 $ 4,683,440 × 7.53763 $320,000 2,412,042 $ 7,095,482 Ex 15–13 a Cash Premium on Bonds Payable Bonds Payable 7,789,543 289,543 7,500,000 Note: The following data are in support of the determination of the proceeds of the bond issue stated in the exercise: Present value of $1 for 10 (semiannual) periods at 5% (semiannual rate) 0.61391 Face amount × $7,500,000 $ 4,604,325 Present value of an annuity of $1 for 10 periods at 5% Semiannual interest payment × Proceeds 3,185,218 $ 7,789,543 b Interest Expense Premium on Bonds Payable Cash 7.72174 $412,500 383,546 28,954* 412,500 *$289,543 ÷ 10 semiannual payments Ex 15–14 2006 Apr Oct 2010 Oct Cash Bonds Payable 12,000,000 Interest Expense Cash 480,000 Bonds Payable Loss on Redemption of Bonds Cash 12,000,000 240,000 12,000,000 480,000 12,240,000 Ex 15–15 2006 Jan July 2012 July Cash Bonds Payable 18,000,000 Interest Expense Cash 810,000 Bonds Payable Gain on Redemption of Bonds Cash 18,000,000 18,000,000 810,000 540,000 17,460,000 Ex 15–16 The significant loss on redemption of the series X bonds should be reported in the Other Income and Expense section of the income statement, rather than as an extraordinary loss The series Y bonds outstanding at the end of the current year should be reported as a noncurrent liability on the balance sheet because they are to be paid from funds set aside in a sinking fund Ex 15–17 The discount of $811 ($1,000 – $189) is amortized as interest revenue over the life of the bonds, using the straight-line method (illustrated in this chapter) or the interest method (illustrated in the appendix to this chapter) Ex 15–18 a Investment in Pierce Co Bonds Interest Revenue Cash 456,750 9,000 b Cash Interest Revenue 18,000 c 465,750 18,000 Interest Revenue Investment in Pierce Co Bonds 540 d Cash Loss on Sale of Investments Investment in Pierce Co Bonds Interest Revenue 448,500 8,250 540 453,750 3,000 Ex 15–19 a Investment in Theisen Co Bonds Interest Revenue Cash 264,600 2,250 b Cash Interest Revenue 6,750 c 266,850 6,750 Investment in Theisen Co Bonds Interest Revenue 450 d Cash Investment in Theisen Co Bonds Gain on Sale of Investments Interest Revenue 274,500 450 267,250 2,750 4,500 Ex 15–20 a Current year: Number of times interest charges earned: 4.7 = Preceding year: Number of times interest charges earned: 12.6 = $392,682,0 00 + $106,023,0 00 $106,023,0 00 $827,659,0 00 + $69,827,00 $69,827,00 b The number of times interest charges earned has declined from 12.6 to 4.7 in the current year Although Southwest Airlines has adequate earnings to pay interest, the decline in this ratio would potentially cause concern among debtholders Appendix Ex 15–21 a Cash Discount on Bonds Payable Bonds Payable 7,095,482 904,518 Interest Expense Cash 320,000 Interest Expense Cash 320,000 Interest Expense Discount on Bonds Payable 144,367 8,000,000 320,000 320,000 144,367 Computations: $7,095,482 × 0.055 = $390,252 $390,252 – $320,000 = $70,252 first semiannual amortization $7,095,482 + $70,252 = $7,165,734 $7,165,734 × 0.055 = $394,115 $394,115 – $320,000 = $74,115 second semiannual amortization $70,252 + $74,115 = $144,367 amortization for first year Note: The following data in support of the proceeds of the bond issue stated in the exercise are presented for the instructor’s information Students are not required to make the computations Present value of $1 for 10 (semiannual) periods at 1/2% (semiannual rate) Face amount Present value of annuity of $1 for 10 periods at 1/2% Semiannual interest payment Total present value of bonds payable b Annual interest paid Plus discount amortized Interest expense for first year 0.58543 × $8,000,000 $ 4,683,440 × 7.53763 $320,000 2,412,042 $ 7,095,482 $640,000 144,367 $784,367 Appendix Ex 15–22 a Interest Expense Cash 412,500 Interest Expense Cash 412,500 Premium on Bonds Payable Interest Expense 47,197 412,500 412,500 47,197 Computations: $7,789,543 × 5% = $389,477 $412,500 – $389,477 = $23,023 first semiannual amortization $7,789,543 – $23,023 = $7,766,520 $7,766,520 × 5% = $388,326 $412,500 – $388,326 = $24,174 second semiannual amortization $23,023 + $24,174 = $47,197 first year amortization b Annual interest paid Less premium amortized Interest expense for first year $825,000 47,197 $777,803 Appendix Ex 15–23 a Present value of $1 for 10 (semiannual) periods at 1/2% (semiannual rate) 0.58543 Face amount × $32,500,000 $19,026,475 Present value of annuity of $1 for 10 periods at 1/2% 7.53763 Semiannual interest payment × $1,950,000 Proceeds of bond sale 14,698,378 $33,724,853 b First semiannual interest payment 1/2% of carrying amount of $33,724,853 Premium amortized $ 1,950,000 1,854,867 $ 95,133 c $ 1,950,000 1,849,635 $ 100,365 Second semiannual interest payment 1/2% of carrying amount of $33,629,720* Premium amortized *$33,724,853 – $95,133 = $33,629,720 d Annual interest paid Less premium amortized Interest expense for first year *$95,133 + $100,365 = $195,498 $ 3,900,000 195,498* $ 3,704,502 Prob 15–4B 2005 July Dec 2006 June Dec 2007 July Cash Premium on Bonds Payable Bonds Payable 16,104,095 31 Interest Expense Cash 1,050,000 31 Premium on Bonds Payable Interest Expense 110,409 31 Income Summary Interest Expense 939,591 30 Interest Expense Cash 1,050,000 31 Interest Expense Cash 1,050,000 31 Premium on Bonds Payable Interest Expense 220,818 31 Income Summary Interest Expense 1,879,182 Bonds Payable Premium on Bonds Payable Gain on Redemption on Bonds Cash 15,000,000 662,459 a b Initial carrying amount of bonds Premium amortized on December 31, 2005 Premium amortized on December 31, 2006 Carrying amount of bonds, December 31, 2006 1,104,095 15,000,000 1,050,000 110,409 939,591 1,050,000 1,050,000 220,818 1,879,182 512,459 15,150,000 2005: $939,591 2006: $1,879,182 $16,104,095 (110,409) (220,818) $15,772,868 Prob 15–4B Concluded This solution is applicable only if the P.A.S.S Software that accompanies the text is used ABSAROKA CO Balance Sheet July 1, 2007 Assets Cash $ 2,931,604 Accounts receivable 728,950 Merchandise inventory 4,681,650 Prepaid insurance 139,650 Supplies 182,950 Total current assets $ 8,664,804 Equipment $ 2,390,000 Accumulated depreciation—equipment (109,600) $ 2,280,400 Building $ 7,405,000 Accumulated depreciation—building (772,018) 6,632,982 Total plant assets 8,913,382 Total assets $ 17,578,186 Liabilities Accounts payable $ 32,000 Stockholders’ Equity Paid-in capital: Preferred stock $ 4,100,000 Excess of issue price over par—preferred stock 672,500 Common stock 6,500,000 Excess of issue price over par—common stock 1,600,000 From sale of treasury stock 2,000 Total paid-in capital $12,874,500 Retained earnings 4,891,686 Total $ 17,766,186 Less treasury stock 220,000 Total stockholders’ equity 17,546,186 Total liabilities and equity $ 17,578,186 Prob 15–5B 2005 Sept Dec 31 31 2010 June 30 Oct 31 31 Dec 31 31 Investment in Churchill Company Bonds Interest Revenue ($400,000 × 9% × 2/12) Cash 385,720 6,000 Cash Interest Revenue 18,000 Investment in Churchill Company Bonds Interest Revenue 240 Cash Interest Revenue 18,000 Investment in Churchill Company Bonds Interest Revenue 300 391,720 18,000 240 18,000 300 Cash 198,600* Loss on Sale of Investments 2,120 Investment in Churchill Company Bonds Interest Revenue *($200,000 × 0.965) + ($200,000 × 9% × 4/12) – $400 Cash Interest Revenue 9,000 Investment in Churchill Company Bonds Interest Revenue 360 194,720 6,000 9,000 360 Appendix Prob 15–6B a Interest Expense Premium on Bonds Payable [$1,100,000 – (5% × $21,246,231)] Cash 1,062,312 b Interest Expense Premium on Bonds Payable [$1,100,000 – (5% × $21,208,543)] Cash 1,060,427 37,688 1,100,000 39,573 1,100,000 $1,062,312 Appendix Prob 15–7B a Interest Expense Discount on Bonds Payable [($16,878,410 × 5%) – $810,000] Cash 843,921 b Interest Expense Discount on Bonds Payable [($16,912,331 × 5%) – $810,000] Cash 845,617 $843,921 33,921 810,000 35,617 810,000 COMPREHENSIVE PROBLEM a Cash Common Stock Paid-in Capital in Excess of Par— Common Stock 520,000 b Cash Preferred Stock Paid-in Capital in Excess of Par— Preferred Stock 1,000,000 c Cash Bonds Payable Premium on Bonds Payable 12,747,739 250,000 270,000 800,000 200,000 12,000,000 747,739 Computations: Present value of face amount: $12,000,000 × 0.37689 [present value of $1 for 20 (semiannual) periods at 5% (semiannual rate)] Present value of semiannual interest payments of $660,000 at 5% compounded semiannually: $660,000 × 12.46221 (present value of annuity of $1 for 20 periods at 5%) Total present value of bonds $ 4,522,680 8,225,059 $ 12,747,739 d Cash Dividends Cash Dividends Payable 55,000 e Cash Dividends Payable Cash 55,000 f Bonds Payable Premium on Bonds Payable Cash Gain on Redemption of Bonds 400,000 4,920 g Treasury Stock Cash 250,000 55,000 55,000 404,000 920 250,000 Comp Prob Continued h Stock Dividends Cash Dividends Stock Dividends Distributable Paid-In Capital in Excess of Par— Common Stock Cash Dividends Payable 96,900* 30,000 47,500 49,400 30,000 *100,000 – 5,000 = 95,000 95,000 × 2% = 1,900 1,900 × $51 = $96,900 i Stock Dividends Distributable Cash Dividends Payable Common Stock Cash 47,500 30,000 j Investment in Athens Sports Inc Bonds Interest Revenue Cash 116,400 4,500 k Cash Treasury Stock Paid-In Capital from Sale of Treasury Stock 174,000 l Interest Expense Premium on Bonds Payable Cash 622,613 37,387 47,500 30,000 120,900 150,000 24,000 660,000 Computations: Semiannual interest payment Amortization premium [($747,739 ÷ 120 months) × months, rounded] Interest expense m Interest Receivable Interest Revenue $660,000 37,387 $622,613 6,000 6,000 Computation: $120,000 × 15% × 4/12 = $6,000 Investment in Athens Sports Inc Bonds Interest Revenue 120 120 Comp Prob Continued a HUBCAP PRODUCTS INC Income Statement For the Year Ended July 31, 2006 Sales Cost of merchandise sold Gross profit Operating expenses: Selling expenses: Sales salaries expense Sales commissions Advertising expense Depreciation expense—store buildings and equipment Delivery expense Store supplies expense Miscellaneous selling expense Administrative expenses: Office salaries expense Office rent expense Depreciation expense—office buildings and equipment Office supplies expense Miscellaneous administrative expense Special charges: Restructuring charges Fixed asset impairment Total operating expenses Income from operations Other expenses and income: Interest revenue Gain on redemption of bonds (net of applicable income tax of $120) Interest expense Income from continuing operations before income tax Income tax Income from continuing operations Loss from disposal of a business segment Less applicable income tax Net income $ 5,040,000 2,799,000 $ 2,241,000 $288,000 156,000 120,000 72,000 27,000 16,000 11,000 $690,000 $136,000 40,000 20,000 8,000 6,000 210,000 $ 75,000 150,000 225,000 1,125,000 $ 1,116,000 $ 1,620 800 (622,613) (620,193) $ $ 495,807 198,007 297,800 $ 120,000 177,800 $200,000 80,000 Comp Prob Continued Earnings per common share: Income from continuing operations Loss on discontinued operations Net income $1.93* 1.20 $0.73 *($297,800 – $105,000 preferred dividends) ÷ 100,000 common shares b HUBCAP PRODUCTS INC Retained Earnings Statement For the Year Ended July 31, 2006 Retained earnings, August 1, 2005 Net income for year Less dividends: Cash dividends Stock dividends Decrease in retained earnings Retained earnings, July 31, 2006 $1,754,148 $177,800 $160,000 96,900 256,900 79,100 $1,675,048 Comp Prob Continued c HUBCAP PRODUCTS INC Balance Sheet July 31, 2006 Assets Current assets: Cash $ 200,000 Accounts receivable $ 450,000 Less allowance for doubtful accounts 35,000 415,000 Notes receivable 125,000 Merchandise inventory, at lower of cost (fifo) or market 680,000 Interest receivable 6,000 Prepaid expenses 25,000 Total current assets $ 1,451,000 Investments: Investment in Athens Sports bonds 116,520 Property, plant, and equipment: Store buildings and equipment $16,450,000 Less accumulated depreciation 3,543,000 $12,907,000 Office buildings and equipment $ 5,930,000 Less accumulated depreciation 1,336,520 4,593,480 Total property, plant, and equipment 17,500,480 Intangible assets: Goodwill 432,000 Total assets $19,500,000 Comp Prob Concluded Liabilities Current liabilities: Accounts payable Employee termination obligation Income tax payable Dividends payable Deferred income tax payable Total current liabilities Long-term liabilities: Bonds payable, 11%, due 2016 Add premium on bonds payable Deferred credits: Deferred income tax payable Total liabilities $ 175,000 65,000 32,000 30,000 7,500 $ $12,000,000 710,352 309,500 12,710,352 33,600 $13,053,452 Stockholders’ Equity Paid-in capital: Preferred 8% stock, $100 par (30,000 shares authorized; 15,000 shares issued) $ 1,500,000 Excess of issue price over par 240,000 $ 1,740,000 Common stock, $25 par (400,000 shares authorized; 101,900 shares issued) $ 2,547,500 Excess of issue price over par 560,000 3,107,500 From sale of treasury stock 24,000 Total paid-in capital $ 4,871,500 Retained earnings 1,675,048 Total $ 6,546,548 Deduct treasury common stock (2,000 shares at cost) 100,000 Total stockholders’ equity 6,446,548 Total liabilities and stockholders’ equity $ 19,500,000 SPECIAL ACTIVITIES Activity 15–1 a Gatorade® was developed in the 1960s by scientists at the University of Florida for use by the University’s football team, the Florida Gators; hence, the name Gatorade Gatorade was designed to replace fluid and electrolytes that the players lost through sweat during practices and games In the 1967 Orange Bowl, the football team used Gatorade to overpower its dehydrated opponent, Georgia Tech, 27 to 12 b Gatorade has approximately 85% of the sports-drink market a Some overlap in descriptions exists; however, sports, lifestyle, and active thirst drinks are normally defined as follows: Sports drinks are designed to replace fluid and electrolytes consumed during athletic activities Lifestyle drinks are designed to be appropriate for any occasion Active thirst drinks are drinks that people consume when they are “hot and thirsty.” b Although drinks can cross over into more than one category, examples include the following: Sports drinks: Gatorade, Powerade®, Red Bull® Lifestyle drinks: Coke ®, Pepsi®, iced tea, bottled water, coffee, beer, wine, various liquors Active thirst drinks: Tap water, bottled water, Coke, Pepsi, iced tea, beer, Gatorade, Powerade PepsiCo decided to emphasize the origins of Gatorade as a sports drink in its advertising campaign Rather than lose its identity, PepsiCo decided to “stay true” to its user base and strength as a sports drink Thus, Gatorade’s new advertising campaign emphasizes the origins of the development of Gatorade to enhance player performance Note: A survey conducted by PepsiCo on Gatorade’s origin revealed that 26% thought it was developed by Dr Gator, while over 2% thought it contained a “secret ingredient” of alligator juice Source: Betsy McKay, “Gatorade Seeks to Dominate Sports Drink Realm With Ads,” The Wall Street Journal, June 11, 2002; http://gatorade.com Activity 15–2 GE Capital’s action was legal, but caused a great public relations stir at the time Some quotes: “A lot of people feel like they have been sorely used,” said one bond fund manager “There was nothing illegal about it, but it was nasty.” The fund manager said that GE Capital’s decision to upsize its bond issue to $11 billion from $6 billion midway through the offering ordinarily wouldn’t have upset bondholders “But then to find out two days later that they had filed a $50 billion shelf?” he said “People buy GE because it’s like buying Treasurys, not because they want to get jerked around.” GE Capital’s action was probably ethical, even though it caused some stir In its own defense it stated: In a statement released late Thursday, GE Capital said “with the $11 billion bond issuance of March 13, GE Capital exhausted its existing debt shelf registration; consequently, on March 20, GE Capital filed a $50 billion shelf registration.” The release said the shelf filing was not an offering and that it would be used in part to roll over $31 billion in maturing long term debt In retrospect, GE Capital could have been a little more forthcoming about its financing plans prior to selling the $11 billion on bonds, but there was nothing unethical or illegal about its disclosures Source: “GE Capital Timing On $50B Shelf Filing Added To Backlash,” Dow Jones Capital Markets Report, March 22, 2002, Copyright (c) 2002, Dow Jones & Company, Inc Activity 15–3 Without the consent of the bondholders, Terry Holter’s use of the sinking fund cash to temporarily alleviate the shortage of funds would violate the bond indenture contract and the trust of the bondholders It would therefore be unprofessional In addition, the use of Terry’s brother-in-law as trustee of the sinking fund is a potential conflict of interest that could be considered unprofessional Activity 15–4 Theoretically, accountants would be justified in using present values to value all liabilities presented in the balance sheet As a practical matter, however, current liabilities that will be paid within one year are presented at their face value, since this value usually approximates the present value of the liability Other liabilities such as pensions and lease obligations involve complex assumptions that include considering the present values Finally, generally accepted accounting principles require that long-term liabilities be amortized using present values (the effective interest rate method) The straight-line amortization method may be used if the results are not materially different from those of the effective interest rate method In this chapter, we have used the straight-line method to simplify our discussions The effective interest rate method is illustrated in an appendix to the chapter Activity 15–5 The primary advantage of issuing preferred stock rather than bonds is that the preferred stock does not obligate Beacon to pay dividends, while interest on bonds must be paid That is, the issuance of bonds will require annual interest payments, thus necessitating a periodic (probably semiannual) cash outflow Given Extreme Fun’s volatility of operating cash flows, the required interest payments might strain Beacon’s liquidity In the extreme, this could even lead to a bankruptcy of Beacon The issuance of bonds has the advantage of providing a tax deduction for interest expense This would tend to reduce the net (aftertax) cost of the bonds Probably the safest alternative is for Beacon to issue preferred stock Of course, another alternative might be to issue a combination of preferred stock and bonds Activity 15–6 Note to Instructors: The purpose of this activity is to familiarize students with bonds as an investment and the sources of information about bonds Activity 15–7 Shares of common stock Earnings before bond interest and income tax Deduct interest on bonds Income before income tax Deduct income tax Net income Plan 160,000 $1,400,000 800,000 $ 600,000 240,000 $ 360,000 Plan 300,000 $1,400,000 520,000 $ 880,000 352,000 $ 528,000 Earnings per share on common stock $ $ a b 2.25 1.76 Factors to be considered in addition to earnings per share: There is a definite legal obligation to pay interest on bonds, but there is no definite commitment to pay dividends on common stock Therefore, if net income should drop substantially, bonds would be less desirable than common stock If the bonds are issued, there is a definite commitment to repay the principal in 20 years In case of liquidation, the claims of the bondholders would rank ahead of the claims of the common stockholders Present stockholders must purchase the new stock if they are to retain their proportionate control and financial interest in the corporation Since the net income has been relatively stable in the past and anticipated earnings under Plan offer $2.25 more per share for the common stockholder, Plan appears to be somewhat more advantageous for present stockholders Activity 15–8 Note to Instructors: The purpose of this activity is to familiarize students with bond ratings and the importance of bond ratings to the issuer as well as to the investor ... Plan $15, 000,000 — $15, 000,000 6,000,000 $ 9,000,000 — $ 9,000,000 ÷ 4,000,000 $ 2.25 Plan $15, 000,000 — $15, 000,000 6,000,000 $ 9,000,000 600,000 $ 8,400,000 ÷ 2,000,000 $ 4.20 Plan $15, 000,000... 1,104,095 15, 000,000 1,050,000 110,409 939,591 1,050,000 1,050,000 220,818 1,879,182 512,459 15, 150,000 2005: $939,591 2006: $1,879,182 $16,104,095 (110,409) (220,818) $15, 772,868 Prob 15 4B Concluded... $7,095,482 + $70,252 = $7,165,734 $7,165,734 × 0.055 = $394, 115 $394, 115 – $320,000 = $74, 115 second semiannual amortization $70,252 + $74, 115 = $144,367 amortization for first year Note: The following