Chapter Review
14-9fExercises
Effect of Financing On Earnings per Share
Obj. 1
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Henriksen Co., which produces and sells biking equipment, is financed as follows:
Bonds payable, 5% (issued at face amount) $6,000,000 Preferred $2.00 stock, $100 par 3,000,000 Common stock, $25 par 5,000,000 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) $900,000, (b) $1,100,000, and (c) $1,500,000.
AnswerCheck Figure: b. $2.10
Evaluate Alternative Financing Plans
Obj. 1
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Based on the data in Exercise 14-1, what factors other than earnings per share should be considered in evaluating these alternative financing plans?
Corporate Financing
Obj. 1
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The financial statements for Nike, Inc., are presented in Appendix C at the end of the text. What is the major source of financing for Nike?
Bond Price
Obj. 3
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Stone Energy Corporation’s 7.5% bonds due in 2022 were reported as selling for 77.00.
Were the bonds selling at a premium or at a discount? Why is Stone Energy Corporation able to sell its bonds at this price?
Entries for Issuing Bonds
Obj. 3
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Abioye Co. produces and distributes semiconductors for use by computer manufacturers. Abioye Co. issued $700,000 of 10-year, 9% bonds on May 1 of the current year at face value, with interest payable on May 1 and November 1. The fiscal year of the company is the calendar year. Journalize the entries to record the following selected transactions for the current year:
May 1 Issued the bonds for cash at their face amount. Nov. 1. Paid the interest on the bonds. Dec. 31. Recorded accrued interest for two months.
Entries for Issuing Bonds and Amortizing Discount By Straight-Line Method
Obj. 2, 3
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On the first day of its fiscal year, Jacinto Company issued $6,500,000 of six-year, 7% bonds to finance its operations of producing and selling home improvement products. Interest is payable semiannually. The bonds were issued at a market (effective) interest rate of 8%, resulting in Jacinto Company receiving cash of $6,194,985.
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Journalize the entries to record the following:
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Issuance of the bonds.
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First semiannual interest payment. The bond discount amortization is combined with the semiannual interest payment. Round to the nearest dollar.
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Second semiannual interest payment. The bond discount amortization is combined with the semiannual interest payment. Round to the nearest dollar.
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Determine the amount of the bond interest expense for the first year.
AnswerCheck Figure: $505,836
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Explain why the company was able to issue the bonds for only $6,194,985 rather than for the face amount of $6,500,000.
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Obj. 2, 3
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Favreau Corporation wholesales repair products to equipment manufacturers. On April 1, Year 1, Favreau Corporation issued $35,000,000 of five-year, 7% bonds at a market (effective) interest rate of 6%, receiving cash of $36,492,785. Interest is payable semiannually on April 1 and October 1. Journalize the entries to record the following:
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Issuance of bonds on April 1.
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First interest payment on October 1 and amortization of bond premium for six months, using the straight-line method. The bond premium amortization is combined with the semiannual interest payment. Round to the nearest dollar.
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Explain why the company was able to issue the bonds for $36,492,785 rather than for the face amount of $35,000,000.
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Entries for Issuing and Calling Bonds; Loss
Obj. 3
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Rushton Corp., a wholesaler of music equipment, issued $11,000,000 of 20-year, 9% callable bonds on March 1, 20Y1, at their face amount, with interest payable on March 1 and September 1. The fiscal year of the company is the calendar year. Journalize the entries to record the following selected transactions:
20Y1 Mar. 1. Issued the bonds for cash at their face amount. Sept. 1. Paid the interest on the bonds. 20Y5 Sept. 1. Called the bond issue at 101, the rate provided in the bond indenture. (Omit entry for payment of interest.)
Entries for Issuing and Calling Bonds; Gain
Obj. 3
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Emil Corp. produces and sells wind-energy-driven engines. To finance its operations, Emil Corp. issued $15,000,000 of 20-year, 9% callable bonds on May 1, 20Y1, at their face amount, with interest payable on May 1 and November 1. The fiscal year of the company is the calendar year. Journalize the entries to record the following selected transactions:
20Y1 May 1. Issued the bonds for cash at their face amount. Nov. 1. Paid the interest on the bonds. 20Y5 Nov. 1. Called the bond issue at 96, the rate provided in the bond indenture. (Omit entry for payment of interest.)
Entries for Installment Note Transactions
Obj. 4, 5
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On the first day of the fiscal year, Shiller Company borrowed $85,000 by giving a seven-year, 7% installment note to Soros Bank. The note requires annual payments of $15,772, with the first payment occurring on the last day of the fiscal year. The first payment consists of interest of $5,950 and principal repayment of $9,822.
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Journalize the entries to record the following:
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Issued the installment note for cash on the first day of the fiscal year.
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Paid the first annual payment on the note.
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Explain how the notes payable would be reported on the balance sheet at the end of the first year.
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Entries for Installment Note Transactions
Obj. 4
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On January 1, Year 1, Wedekind Company issued a $170,000, five-year, 8% installment note to Shannon Bank. The note requires annual payments of $42,578, beginning on December 31, Year 1. Journalize the entries to record the following:
Year 1 Jan. 1. Issued the note for cash at its face amount. Dec. 31. Paid the annual payment on the note, which consisted of interest of $13,600 and principal of $28,978. Year 4 Dec. 31. Paid the annual payment on the note, including $6,074 of interest. The remainder of the payment reduced the principal balance on the note.
Entries for Installment Note Transactions
Obj. 4
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On January 1, Year 1, Bryson Company obtained a $147,750, four-year, 7% installment note from Campbell Bank. The note requires annual payments of $43,620, beginning on December 31, Year 1.
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Prepare an amortization table for this installment note, similar to the one presented in Exhibit 4. Round to nearest dollar.
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Journalize the entries for the issuance of the note and the four annual note payments.
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Describe how the annual note payment would be reported in the Year 1 income statement.
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Reporting Bonds
Obj. 5
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At the beginning of the current year, two bond issues (Simmons Industries 7%, 20-year bonds and Hunter Corporation 8%, 10-year bonds) were outstanding. During the year, the Simmons Industries bonds were redeemed and a significant loss on the redemption of bonds was reported as cost of merchandise sold on the income statement. At the end of the year, the Hunter Corporation bonds were reported as a noncurrent liability. The maturity date on the Hunter Corporation bonds was early in the following year.
Identify the flaws in the reporting practices related to the two bond issues.
Times Interest Earned
Obj. 6
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The following data were taken from recent annual reports of Southwest Airlines, which operates a low-fare airline service to more than 50 cities in the United States:
Current Year Prior Year Interest expense $ 131,000,000 $ 114,000,000 Income before income tax expense 3,164,000,000 3,265,000,000 -
Determine the times interest earned ratio for the current and preceding years. Round to one decimal place.
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What conclusions can you draw?
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Times Interest Earned
Obj. 6
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Loomis, Inc., reported the following on the company’s income statement in two recent years:
Current Year Prior Year Interest expense $ 13,500,000 $ 16,000,000 Income before income tax expense 310,500,000 432,000,000 -
Determine the times interest earned ratio for the current year and the prior year. Round to one decimal place.
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Is this ratio improving or declining?
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Times Interest Earned
Obj. 6
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Iacouva Company reported the following on the company’s income statement for two recent years:
Current Year Prior Year Interest expense $5,000,000 $5,000,000 Income before income tax expense 3,500,000 6,000,000 -
Determine the times interest earned ratio for the current year and the prior year. Round to one decimal place.
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What conclusions can you draw?
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Present Value of Amounts Due
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Tommy John is going to receive $1,000,000 in three years. The current market rate of interest is 10%.
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Using the present value of $1 table in Exhibit 8, determine the present value of this amount compounded annually.
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Why is the present value less than the $1,000,000 to be received in the future?
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Present Value of an Annuity
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Determine the present value of $200,000 to be received at the end of each of four years, using an interest rate of 7%, compounded annually, as follows:
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By successive computations, using the present value table in Exhibit 8.
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By using the present value table in Exhibit 10.
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Why is the present value of the four $200,000 cash receipts less than the $800,000 to be received in the future?
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Present Value of an Annuity
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On January 1, you win $60,000,000 in the state lottery. The $60,000,000 prize will be paid in equal installments of $6,000,000 over 10 years. The payments will be made on December 31 of each year, beginning on December 31 of the current year. If the current interest rate is 6%, determine the present value of your winnings. Use the present value tables in Appendix A.
AnswerCheck Figure: $44,160,540
Present Value of an Annuity
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Assume the same data as in Exercise 14-19, except that the current interest rate is 10%.
Will the present value of your winnings using an interest rate of 10% be more than the present value of your winnings using an interest rate of 6%? Why or why not?
Present Value of Bonds Payable; Discount
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Pinder Co. produces and sells high-quality video equipment. To finance its operations, Pinder Co. issued $25,000,000 of five-year, 7% bonds, with interest payable semiannually, at a market (effective) interest rate of 9%. Determine the present value of the bonds payable, using the present value tables in Exhibits 8 and 10. Round to the nearest dollar.
Present Value of Bonds Payable; Premium
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Moss Co. issued $42,000,000 of five-year, 11% bonds, with interest payable semiannually, at a market (effective) interest rate of 9%. Determine the present value of the bonds payable using the present value tables in Exhibits 8 and 10. Round to the nearest dollar.
AnswerCheck Figure: $45,323,443
Amortize Discount By Interest Method
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On the first day of its fiscal year, Ebert Company issued $50,000,000 of 10-year, 7% bonds to finance its operations. Interest is payable semiannually. The bonds were issued at a market (effective) interest rate of 9%, resulting in Ebert Company receiving cash of $43,495,895. The company uses the interest method.
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Journalize the entries to record the following:
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Sale of the bonds.
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First semiannual interest payment, including amortization of discount. Round to the nearest dollar.
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Second semiannual interest payment, including amortization of discount. Round to the nearest dollar.
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Compute the amount of the bond interest expense for the first year.
AnswerCheck Figure: $3,923,959
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Explain why the company was able to issue the bonds for only $43,495,895 rather than for the face amount of $50,000,000.
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Amortize Premium By Interest Method
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Shunda Corporation wholesales parts to appliance manufacturers. On January 1, Year 1, Shunda Corporation issued $22,000,000 of five-year, 9% bonds at a market (effective) interest rate of 7%, receiving cash of $23,829,684. Interest is payable semiannually. Shunda Corporation’s fiscal year begins on January 1. The company uses the interest method.
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Journalize the entries to record the following:
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Sale of the bonds.
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First semiannual interest payment, including amortization of premium. Round to the nearest dollar.
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Second semiannual interest payment, including amortization of premium. Round to the nearest dollar.
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Determine the bond interest expense for the first year.
AnswerCheck Figure: $1,662,619
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Explain why the company was able to issue the bonds for $23,829,684 rather than for the face amount of $22,000,000.
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Compute Bond Proceeds, Amortizing Premium By Interest Method, and Interest Expense
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Ware Co. produces and sells motorcycle parts. On the first day of its fiscal year, Ware Co. issued $35,000,000 of five-year, 12% bonds at a market (effective) interest rate of 10%, with interest payable semiannually. Compute the following, presenting figures used in your computations:
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The amount of cash proceeds from the sale of the bonds. Use the tables of present values in Exhibits 8 and 10. Round to the nearest dollar.
AnswerCheck Figure: $37,702,483
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The amount of premium to be amortized for the first semiannual interest payment period, using the interest method. Round to the nearest dollar.
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The amount of premium to be amortized for the second semiannual interest payment period, using the interest method. Round to the nearest dollar.
AnswerCheck Figure: $225,620
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The amount of the bond interest expense for the first year.
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Compute Bond Proceeds, Amortizing Discount By Interest Method, and Interest Expense
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Boyd Co. produces and sells aviation equipment. On the first day of its fiscal year, Boyd Co. issued $80,000,000 of five-year, 9% bonds at a market (effective) interest rate of 12%, with interest payable semiannually. Compute the following, presenting figures used in your computations:
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The amount of cash proceeds from the sale of the bonds. Use the tables of present values in Exhibits 8 and 10. Round to the nearest dollar.
AnswerCheck Figure: $71,167,524
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The amount of discount to be amortized for the first semiannual interest payment period, using the interest method. Round to the nearest dollar.
AnswerCheck Figure: $670,051
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The amount of discount to be amortized for the second semiannual interest payment period, using the interest method. Round to the nearest dollar.
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The amount of the bond interest expense for the first year.
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