Question 1

A corporation plans to invest $1 million in oil exploration. The corporation is considering two plans to raise the money. Under Plan #1, bonds with a contract rate of interest of 6% would be issued. Under Plan #2, 50,000 additional shares of common stock would be issued at $20 per share. The corporation currently has 300,000 shares of stock outstanding, and it expects to earn $700,000 per year before bond interest and income taxes. The net income and return on investment for both plans is shown below:
 $\begin{array}{|l|c|c|}
\hline &\underline{\text { Plan \#1 }} &\underline{\text { Plan \#2 }}\ 
\hline \text { Earnings before bond interest and taxes. } & \$ 700,000& \$ 700,000 \
\hline \text { Bond interest expense } & (60,000) &\
\hline \text { Income before } & \$ 640,000&\$700,000 \
\hline
\end{array}$  $\begin{array}{|l|c|c|}
\hline \text { Income before taxes } & \$ 640,000 & \$ 700,000 \
\hline \text { Income taxes} & (224,000) & (245,000) \
\hline \text { Net income. } & \$ 416,000 & \$ 455,000 \
\hline\
\hline \text { Equity. } & \$ 8,000,000 & \$ 9,000,000 \
\hline \text { Return on Equity. } & 5.2 \% & 5.06 \% \
\hline
\end{array}$ Comment on the relative effects of each alternative, including when one form of financing is preferred to another.

Accepted Answer

The answer of A corporation plans to invest $1 million...

Question 2

What are methods that a company may use to retire its bonds?

Accepted Answer

The answer of What are methods that a company may...

Question 3

A company has 10%, 20-year bonds outstanding with a par value of $500,000. The company calls the bonds at 96 when the unamortized discount is $24,500. Calculate the gain or loss on the retirement of these bonds.

Accepted Answer

The answer of A company has 10%, 20-year bonds outstanding...

Question 4

On January 1, $300,000 of par value bonds with a carrying value of $310,000 is converted to 50,000 shares of $5 par value common stock. The entry to record the conversion of the bonds includes all of the following entries except:

Accepted Answer

A)  Credit to Paid-In Capital in Excess of Par Value, Common Stock $60,000. 
B)  Debit to Bonds Payable $310,000. 
C)  Debit to Premium on Bonds Payable $10,000. 
D)  Credit to Common Stock $250,000. 
E)  Debit to Bonds Payable $300,000.

Question 5

A bond's par value is not necessarily the same as its market value.

Accepted Answer

A) True 
 B)False

Question 6

The factor for the present value of an annuity at 8% for 10 years is 6.7101. This implies that an annuity of ten $15,000 payments at 8% yields a present value of $2,235.

Accepted Answer

A) True 
 B)False

Question 7

The debt-to-equity ratio is calculated by dividing total stockholders' equity by total liabilities.

Accepted Answer

A) True 
 B)False

Question 8

On January 1, a company issues bonds dated January 1 with a par value of $400,000. The bonds mature in 5 years. The contract rate is 7%, and interest is paid semiannually on June 30 and December 31. The market rate is 8% and the bonds are sold for $383,793. 
-The journal entry to record the first interest payment using the effective interest method of amortization is:

Accepted Answer

A)  Debit Interest Payable $14,000.00; credit Cash $14,000.00. 
B)  Debit Interest Expense $15,351.72; credit Premium on Bonds Payable $1,351.72; credit Cash $14,000.00. 
C)  Debit Interest Expense $12,648.28; debit Discount on Bonds Payable $1,351.72; credit Cash $14,000.00. 
D)  Debit Interest Expense $15,351.72; credit Discount on Bonds Payable $1,351.72; credit Cash $14,000.00. 
E)  Debit Interest Expense $12,648.28; debit Premium on Bonds Payable $1,351.72; credit Cash $14,000.00.

Question 9

The market rate for bonds is generally higher when the time period to maturity is longer due to the risk of adverse events occurring over the time period.

Accepted Answer

A) True 
 B)False

Question 10

The factor for the present value of an annuity for 6 years at 10% is 4.3553. This implies that an annuity of six $2,000 payments at 10% is the equivalent of $8,710.60 today.

Accepted Answer

A) True 
 B)False

Question 11

A company issued 9.2%, 10-year bonds with a par value of $100,000. Interest is paid semiannually. The annual market interest rate on the issue date was 10%, and the issuer received $95,016 cash for the bonds. The issuer uses the effective interest method for amortization. On the first semiannual interest date, what amount of discount should the issuer amortize?

Accepted Answer

The answer of A company issued 9.2%, 10-year bonds with...

Question 12

________ bonds can be exchanged for a fixed number of shares of the issuing corporation's common stock.

Accepted Answer

The answer of ________ bonds can be exchanged for a...

Question 13

A company's debt-to-equity ratio was 1.0 at the end of Year 1. By the end of Year 2, it had increased to 1.7. Since the ratio increased from Year 1 to Year 2, the degree of risk in the firm's financing structure decreased during Year 2.

Accepted Answer

A) True 
 B)False

Question 14

An ________ is a series of equal payments at equal time intervals.

Accepted Answer

The answer of An ________ is a series of equal...

Question 15

On January 1, a company issued and sold a $400,000, 7%, 10-year bond payable, and received proceeds of $396,000. Interest is payable each June 30 and December 31. The company uses the straight-line method to amortize the discount. 
-The journal entry to record the first interest payment is:

Accepted Answer

A)  Debit Bond Interest Expense $14,000; credit Cash $14,000. 
B)  Debit Bond Interest Expense $14,200; credit Cash $14,000; credit Discount on Bonds Payable $200. 
C)  Debit Bond Interest Expense $28,000; credit Cash $28,000. 
D)  Debit Bond Interest Expense $14,000; debit Discount on Bonds Payable $200; credit Cash $14,200. 
E)  Debit Bond Interest Expense $13,800; debit Discount on Bonds Payable $200; credit Cash $14,000.

Question 16

Payments on an installment note normally include the accrued interest expense plus a portion of the amount borrowed.

Accepted Answer

A) True 
 B)False

Question 17

When a bond sells at a premium:

Accepted Answer

A)  The contract rate is below the market rate. 
B)  The bond pays no interest. 
C)  The contract rate is above the market rate. 
D)  It means that the bond is a zero coupon bond. 
E)  The contract rate is equal to the market rate.

Question 18

Promissory notes that require the issuer to make a series of payments consisting of both interest and principal are:

Accepted Answer

A)  Investment notes. 
B)  Debentures. 
C)  Indentures. 
D)  Installment notes. 
E)  Discounted notes.

Question 19

A disadvantage of bond financing is:

Accepted Answer

A)  Bonds do not affect owners' control. 
B)  Bonds can increase return on equity. 
C)  Interest on bonds is tax deductible. 
D)  Bonds pay periodic interest and the repayment of par value at maturity. 
E)  It allows firms to trade on the equity.

Question 20

Compounded means that interest during a second period is based on the total amount borrowed plus the interest accrued in the first period.

Accepted Answer

A) True 
 B)False

Exam 14: Long-Term Liabilities

What are methods that a company may use to retire its bonds?

A company has 10%, 20-year bonds outstanding with a par value of $500,000. The company calls the bonds at 96 when the unamortized discount is $24,500. Calculate the gain or loss on the retirement of these bonds.

On January 1, $300,000 of par value bonds with a carrying value of $310,000 is converted to 50,000 shares of $5 par value common stock. The entry to record the conversion of the bonds includes all of the following entries except:

A bond's par value is not necessarily the same as its market value.

The factor for the present value of an annuity at 8% for 10 years is 6.7101. This implies that an annuity of ten $15,000 payments at 8% yields a present value of $2,235.

The debt-to-equity ratio is calculated by dividing total stockholders' equity by total liabilities.

The market rate for bonds is generally higher when the time period to maturity is longer due to the risk of adverse events occurring over the time period.

The factor for the present value of an annuity for 6 years at 10% is 4.3553. This implies that an annuity of six $2,000 payments at 10% is the equivalent of $8,710.60 today.

________ bonds can be exchanged for a fixed number of shares of the issuing corporation's common stock.

A company's debt-to-equity ratio was 1.0 at the end of Year 1. By the end of Year 2, it had increased to 1.7. Since the ratio increased from Year 1 to Year 2, the degree of risk in the firm's financing structure decreased during Year 2.

An ________ is a series of equal payments at equal time intervals.

On January 1, a company issued and sold a $400,000, 7%, 10-year bond payable, and received proceeds of $396,000. Interest is payable each June 30 and December 31. The company uses the straight-line method to amortize the discount. -The journal entry to record the first interest payment is:

Payments on an installment note normally include the accrued interest expense plus a portion of the amount borrowed.

When a bond sells at a premium:

Promissory notes that require the issuer to make a series of payments consisting of both interest and principal are:

A disadvantage of bond financing is:

Compounded means that interest during a second period is based on the total amount borrowed plus the interest accrued in the first period.