University of Maryland

ECON 103

1)What would be the total interest cost of the bonds over their full term? A) $1,359,033.

B) $4,640,967.

C) $6,000,000.

D) $7,359,033.

 

 

 

2. On January 1, 2006, Tiny Tim Industries had outstanding $1,000,000 of 12% bonds with a carrying amount of $966,130. The indenture specified a call price of $981,000. The bonds were issued previously at a price to yield 14%. Tiny Tim called the bonds (retired them) on July 1, 2006. What is the amount of the loss on early extinguishment?

A) $0.

B)   $6,932.

C)   $7,241.

D) $7,629

 

 

 

 

 

 

3. Determine the price of a $200,000 bond issue under each of the following independent assumptions:

 

Maturity	Interest Paid	Stated Rate	Effective Rate
1. 10 years	annually	10%	12%
2. 10 years	semiannually	10%	12%
3. 20 years	semiannually	12%	12%

 

 

 

4. Determine the price of a $500,000 bond issue under each of the following independent assumptions:

 

Maturity	Interest Paid	Stated Rate	Effective Rate
1. 10 years	annually	10%	12%
2. 10 years	semiannually	10%	12%
3. 10 years	semiannually	12%	10%

 

 

 

5. On January 1, 2006, Bishop Company issued 10% bonds dated January 1, 2006, with a face amount of $20 million. The bonds mature in 2015 (10 years). For bonds of similar risk and maturity, the market yield is 12%. Interest is paid semiannually on June 30 and December 31.

 

Required:

(1.) Determine the price of the bonds at January 1, 2006.

(2.) Prepare the journal entry to record the bond issuance by Bishop on January 1, 2006. (3.) Prepare the journal entry to record interest on June 30, 2006, using the effective interest

method.

(4.) Prepare the journal entry to record interest on December 31, 2006, using the effective interest method.

 

 

 

 

 

 

6. On January 1, 2006, Mania Enterprises issued 12% bonds dated January 1, 2006, with a face amount of $20 million. The bonds mature in 2015 (10 years). For bonds of similar risk and maturity, the market yield is 10%. Interest is paid semiannually on June 30 and December 31.

 

Required:

(1.) Determine the price of the bonds at January 1, 2006.

(2.) Prepare the journal entry to record the bond issuance by Mania on January 1, 2006.

(3.) Prepare the journal entry to record interest on June 30, 2006, using the effective interest method.

(4.) Prepare the journal entry to record interest on December 31, 2006, using the effective interest method.

 

 

7. On January 1, 2006, Shirley Corporation purchased 10% bonds dated January 1, 2006, with a face amount of $10 million. The bonds mature in 2015 (10 years). For bonds of similar risk and maturity, the market yield is 12%. Interest is paid semiannually on June 30 and December 31.

 

Required:

(1.) Determine the price of the bonds at January 1, 2006.

(2.) Prepare the journal entry to record the bond purchase by Shirley on January 1, 2006. (3.) Prepare the journal entry to record interest on June 30, 2006, using the effective interest

method.

(4.) Prepare the journal entry to record interest on December 31, 2006, using the effective interest method.

 

 

8. On January 1, 2006, Rare Bird Ltd. purchased 12% bonds dated January 1, 2006, with a face amount of $20 million. The bonds mature in 2015 (10 years). For bonds of similar risk and maturity, the market yield is 10%. Interest is paid semiannually on June 30 and December 31.

 

Required:

(1.) Determine the price of the bonds at January 1, 2006.

(2.) Prepare the journal entry to record the bond purchase by Rare Birds on January 1, 2006. (3.) Prepare the journal entry to record interest on June 30, 2006, using the effective interest

method.

(4.) Prepare the journal entry to record interest on December 31, 2006, using the effective interest method.

 

 

 

 

 

9. On January 1, 2006, Cool Universe issued 10% bonds dated January 1, 2006, with a face amount of $20 million. The bonds mature in 2015 (10 years). For bonds of similar risk and maturity, the market yield is 12%. Interest is paid semiannually on June 30 and December 31.

 

Required:

(1.) Determine the price of the bonds at January 1, 2006.

(2.) Prepare the journal entry to record their issuance by Cool on January 1, 2006.

(3.) Prepare the journal entry to record interest on June 30, 2006, using the straight-line method.

(4.) Prepare the journal entry to record interest on December 31, 2006, using the straight-line method.

 

 

10. On January 1, 2006. Boomer Universal issued 12% bonds dated January 1, 2006, with a face amount of $200 million. The bonds mature in 2015 (10 years). For bonds of similar risk and maturity, the market yield is 10%. Interest is paid semiannually on June 30 and December 31.

 

Required:

(1.) Determine the price of the bonds at January 1, 2006.

(2.) Prepare the journal entry to record their issuance by Boomer on January 1, 2006. (3.) Prepare the journal entry to record interest on June 30, 2006, using the straight-line

method.

(4.) Prepare the journal entry to record interest on December 31, 2006, using the straight-line method.

 

 

11. On January 1, 2006, Club Company purchased 10% bonds, dated January 1, 2006, with a face amount of $20 million. The bonds mature in 2015 (10 years). For bonds of similar risk and maturity, the market yield is 12%. Interest is paid semiannually on June 30 and December 31.

 

Required:

(1.) Determine the price of the bonds at January 1, 2006.

(2.) Prepare the journal entry to record the bond purchase by Club on January 1, 2006. (3.) Prepare the journal entry to record interest on June 30, 2006, using the straight-line

method.

(4.) Prepare the journal entry to record interest on December 31, 2006, using the straight-line method.

 

 

12. On January 1, 2006, Field Company purchased 12% bonds, dated January 1, 2006, with a face amount of $20 million. The bonds mature in 2015 (10 years). For bonds of similar risk and maturity, the market yield is 10%. Interest is paid semiannually on June 30 and December 31.

 

Required:

(1.) Determine the price of the bonds at January 1, 2006.

(2.) Prepare the journal entry to record the bond purchase by Field on January 1, 2006. (3.) Prepare the journal entry to record interest on June 30, 2006, using the straight-line

method.

(4.) Prepare the journal entry to record interest on December 31, 2006, using the straight-line method.

 

                                                                                                          

 

13. On February 1, 2006, Lagune & Sons issued 9% bonds dated February 1, 2006, with a face amount of $200,000. The bonds sold for $182,841 and mature in 20 years. The effective interest rate for these bonds was 10%. Interest is paid semiannually on July 31 and January 31. Lagune's fiscal year is the calendar year.

 

Required:

(1.) Prepare the journal entry to record the bond issuance on February 1, 2006.

(2.) Prepare the entry to record interest on July 31, 2006, using the effective interest method. (3.) Prepare the necessary journal entry on December 31, 2006.

(4.) Prepare the necessary journal entry on January 31, 2007.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

14. On February 1, 2006, Sanford & Son issued 10% bonds dated February 1, 2006, with a face amount of $200,000. The bonds sold for $239,588 and mature in 20 years. The effective interest rate for these bonds was 8%. Interest is paid semiannually on July 31 and January 31. Sanford & Son's fiscal year is the calendar year.

 

Required:

(1.) Prepare the journal entry to record the bond issuance on February 1, 2006.

(2.) Prepare the entry to record interest on July 31, 2006, using the effective interest method. (3.) Prepare the necessary journal entry on December 31, 2006.

(4.) Prepare the necessary journal entry on January 31, 2007.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

15. On February 1, 2006, Fox Corporation issued 9% bonds dated February 1, 2006, with a face amount of $200,000. The bonds sold for $182,841 and mature in 20 years. The effective interest rate for these bonds was 10%. Interest is paid semiannually on July 31 and January 31. Fox's fiscal year is the calendar year. Fox uses the straight-line method of amortization.

 

Required:

(1.) Prepare the journal entry to record the bond issuance on February 1, 2006. (2.) Prepare the entry to record interest on July 31, 2006.

(3.) Prepare the necessary journal entry on December 31, 2006. (4.) Prepare the necessary journal entry on January 31, 2007.

 

 

 

 

 

 

16. On February 1, 2006, Wolf Inc. issued 10% bonds dated February 1, 2006, with a face amount of $200,000. The bonds sold for $239,588 and mature in 20 years. The effective interest rate for these bonds was 8%. Interest is paid semiannually on July 31 and January 31. Wolf's fiscal year is the calendar year. Wolf uses the straight-line method of amortization.

 

Required:

(1.) Prepare the journal entry to record the bond issuance on February 1, 2006. (2.) Prepare the entry to record interest on July 31, 2006.

(3.) Prepare the necessary journal entry on December 31, 2006. (4.) Prepare the necessary journal entry on January 31, 2007.

 

 

 

 

17. On January 1, 2005, Slug Corporation issued $6 million of 8%, 10-year convertible bonds at

102. The bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible into 40 shares of $1 par common stock. Fuzz Company purchased 20% of the issue as an investment. On July 1, 2009, Fuzz converted all of its bonds into common stock of Slug. The market price per share for Slug was $32 at the time of the conversion. Both companies use the straight-line method for amortization.

 

Required:

(1.) Prepare journal entries for the issuance of the bonds on the issuer and the investor books. (2.) Prepare the journal entries for the conversion on the books of the issuer and the investor.

 

 

 

18. On August 1, 2004, United Corporation issued $10 million of 8% convertible bonds at 105. The bonds mature in 20 years. Each $1,000 bond was issued with 20 detachable stock warrants, each of which entitled the bondholder to purchase, for $50, one share of United $5 par common stock. World Company purchased 10% of the bond issue. On August 1, 2004, the market value per share for United stock was $56 and the market value of each warrant was $6. In March 2007, when United common stock had a market price of $70 per share and the unamortized premium balance was $300,000, World exercised the warrants it held.

 

Required:

(1.) Prepare the journal entries on August 1, 2004, to record (a) the issuance of the bonds by United and (b) the investment by World.

(2.) Prepare the journal entries for both companies in March 2007 to record the exercise of the warrants.

 

 

 

19. Miranda Company contracted with Stewart Corporation to construct custom-made equipment. The equipment was completed and ready for use on January 1, 2006. Miranda paid for the machine by issuing a $200,000, 3-year note that bears interest at the rate of 4%, payable annually on December 31 each year. Since the machine was custom-built, the cash price was unknown. However, when compared to similar contracts, 10% was deemed to be a reasonable rate of interest.

 

Required:

(1.) Prepare the journal entry by Miranda to record the purchase.

(2.) Prepare journal entries to record interest for each of the first 2 years.

 

                                                                                                                       

 

 

20. The December 31, 2005, balance sheet of Ming Inc. included 12% bonds with a face amount of $100 million. The bonds were issued in 1998 and had a remaining discount of $3,400,000 at December 31, 2005. On January 1, 2006, Ming called the bonds at a price of 102.

 

Required: Prepare the journal entry by Ming to record the retirement of the bonds on January 1, 2006.

 

 

 

21. On May 1, 2006, Green Corporation issued $1,000,000 of 12% bonds, dated January 1, 2006, for $975,000 plus accrued interest. The bonds mature on December 31, 2025, and pay interest semiannually on June 30 and December 31. Green's fiscal year ends on December 31 each year.

 

Required:

(1.) Determine the amount of accrued interest that was included in the proceeds received from the bond sale. Show calculations.

(2.) Prepare the journal entry for the issuance of the bonds.

 

 

 

 

Use the following to answer questions 22-26:

 

On January 1, 2005, Morton Sales Co. issued zero coupon bonds with a face value of $6 million for cash. The bonds mature in 10 years and were issued at a price of $3,050,100.

 

22.   Required: What is the annual effective interest rate in the market when the bonds were issued?

 

 

 

23. Required: What amount of interest expense on these bonds would Morton Sales Co. report in its 2005 income statement?

 

24. Required: How much interest will Morton Sales Co. pay on these bonds in 2005?

 

 

25. Required: What will Morton Sales Co. report on these bonds in its December 31, 2005, balance sheet?

 

26. Required: What total interest expense will Morton Sales Co. report over the 10-year life of these bonds?

 

Use the following to answer questions 27-31:

 

In its 2004 annual report to shareholders, Whole Foods Market, Inc. disclosed the following information about some of its indebtedness:

 

The fair value of convertible subordinated debentures is estimated using quoted market prices. Carrying amounts and estimated fair values of our financial instruments other than those for which carrying amounts approximate fair values as noted above are as follows (in thousands)

 

                          2004                                                          2003                      

Estimated                                              Estimated

Carrying                   Fair                          Carrying                Fair

Amount                Value                        Amount              Value Convertible subordinated debentures                                  $ 158,791             $295,923                    $151,449          $200,396

 

In addition, the company disclosed the following:

 

We have outstanding zero coupon convertible subordinated debentures which had a carrying amount of approximately $158.8 million and $151.4 million at September 26, 2004 and September 28, 2003, respectively. The debentures have an effective yield to maturity of 5 percent and a principal amount at maturity on March 2, 2018 of approximately $308.8 million. The debentures are convertible at the option of the holder, at any time on or prior to maturity, unless previously redeemed or otherwise purchased. The debentures have a conversion rate of 10.640 shares per $1,000 principal amount at maturity, representing approximately 3,280,000 shares. The debentures may be redeemed at the option of the holder on March 2, 2008 or March 2, 2013 at the issue price plus accrued original discount totaling approximately $188 million and $241 million, respectively.

 

27. Required: Explain why the estimated fair value of the debentures exceeds their carrying amount at the end of fiscal year 2004?

 

 

 

28. Required: Why did the carrying amount of the debentures increase during fiscal year 2004?

 

 

 

29. Required: What amount of interest expense will Whole Foods accrue on the debentures during fiscal year 2005?

 

 

                                                   

30. Required: Determine the gain or loss that Whole Foods would have reported in its 2004 income statement if it had repurchased (and retired) the debentures at fair value at the end of the fiscal year?

 

31. Required: Suppose that half of the debenture holders had converted them into Whole Foods stock at the end of the 2004 fiscal year when the stock price is $90 per share. What gain or loss from this conversion would Whole Foods have recorded on the transaction?

 

 

Essay

 

Instructions:

 

The following answers point out the key phrases that should appear in students' answers. They are not intended to be examples of complete student responses. It might be helpful to provide detailed instructions to students on how brief or in-depth you want their answers to be.

 

32. Distinguish between:

1. Secured and unsecured bonds.
2. Coupon and registered bonds.

 

 

 

 

33. Distinguish between:

1. Convertible and callable bonds.
2. Serial and term bonds.

 

 

 

 

34. What is meant by the "market rate" of interest, the "effective rate" of interest, and the "yield rate" of interest?

 

 

 

 

35. How should bond issue costs be accounted for on the books of the issuing corporation?

 

 

 

36. List at least three ways that bonds may be taken off the market prior to maturity.

 

 

 

37. Why do companies find the issuance of convertible bonds to be an attractive form of financing?

 

 

 

 

38. How are bonds and notes the same? How do they differ?

 

 

 

 

39. A zero-coupon bond pays no interest. Explain.