Solution manual accounting 25th editon warren chapter 14

CHAPTER 14
LONG-TERM LIABILITIES: BONDS AND NOTES
DISCUSSION QUESTIONS
1.

(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.

2.

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.

3.

More than face amount. Because comparable bonds provide a market interest rate (11%) that
is less than the rate on the bond being issued (12%), the bond will sell at a premium as the
market’s means of equalizing the two interest rates.

4.

a.

Greater than $26,000,000

b.

1.
2.
3.
4.

$26,000,000
7%
9%
$26,000,000

5.

Less than the contract rate

6.

a.

Premium

b.

$593,454

c.

Premium on Bonds Payable

7.

A loss of $50,000 [($5,000,000 × 0.98) – ($5,000,000 – $150,000)]

8.

A mortgage note is an installment note that is secured by a pledge of the borrower’s assets.
If the borrower fails to pay the note, the lender has the right to take possession of the pledged
asset and sell it to pay off the debt.

9.

A bond is an interest-bearing note that requires periodic interest payments and repayment of
the face amount of the bonds at maturity. Bonds consist of two different components:
(1) interest payments made periodically over the life of the bond and (2) the face amount that
must be repaid at maturity. The periodic payments consist entirely of interest, and the final
payment at maturity consists entirely of principal. Installment notes, on the other hand, have
periodic payments that consist partially of interest and partially of principal. Each payment
reduces the principal on the note so that at maturity the entire amount borrowed will have been
repaid.

10.

a.

As a current liability on the balance sheet.

b.

As a long-term liability on the balance sheet.

14-1
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CHAPTER 14

Long-Term Liabilities: Bonds and Notes

PRACTICE EXERCISES
PE 14–1A
Earnings before bond interest and income tax……………
Deduct interest on bonds………………………………………
Income before income tax……………………………………
Deduct income tax………………………………………………
Net income………………………………………………………
Dividends on preferred stock…………………………………
Available for dividends on common stock…………………
Shares of common stock outstanding………………………
Earnings per share on common stock………………………
1
2
3
4
5

Plan 1

Plan 2

$1,200,000
1
360,000

$1,200,000
3
300,000

$ 840,000
2
336,000

$ 900,000
360,000 4

$ 504,000
0

$ 540,000
5
300,000

$ 504,000
÷ 300,000
$
1.68

$ 240,000
÷ 200,000
$
1.20

Plan 1

Plan 2

$6,000,000 × 6%
$840,000 × 40%
$5,000,000 × 6%
$900,000 × 40%
($3,000,000 ÷ $30) × $3.00

PE 14–1B

Earnings before bond interest and income tax……………
$2,000,000
$2,000,000
1
3
400,000
250,000
Deduct interest on bonds………………………………………
Income before income tax……………………………………… $1,600,000
$1,750,000
4
2
640,000

700,000
Deduct income tax………………………………………………
Net income…………………………………………………………
5
Dividends on preferred stock…………………………………
Available for dividends on common stock………………… Shares of common stock outstanding…………………
Earnings per share on common stock………………………
1
2
3
4
5

$4,000,000 × 10%
$1,600,000 × 40%
$2,500,000 × 10%
$1,750,000 × 40%
($3,000,000 ÷ $25) × $2.50

14-2
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PE 14–2A
Cash
Discount on Bonds Payable
Bonds Payable

PE 14–2B
Cash

Discount on Bonds Payable
Bonds Payable

PE 14–3A
Interest Expense
Discount on Bonds Payable*
Cash
* $79,127 ÷ 10 semiannual payments

PE 14–3B
Interest Expense
Discount on Bonds Payable*
Cash
* $110,401 ÷ 10 semiannual payments

PE 14–4A
Cash
Premium on Bonds Payable
Bonds Payable

PE 14–4B
Cash
Premium on Bonds Payable
Bonds Payable

14-3
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PE 14–5A

Interest Expense
Premium on Bonds Payable*
Cash
* $175,041 ÷ 10 semiannual payments

PE 14–5B
Interest Expense
Premium on Bonds Payable*
Cash
* $308,869 ÷ 10 semiannual payments

PE 14–6A
Bonds Payable
Loss on Redemption of Bonds
Discount on Bonds Payable
Cash

PE 14–6B
Bonds Payable
Premium on Bonds Payable
Gain on Redemption of Bonds
Cash

PE 14–7A
a.

b.

Cash
Notes Payable

Issued installment notes for cash.
Interest Expense
Notes Payable
Cash
Paid principal and interest on installment notes.


PE 14–7B
a.

b.

Cash
Notes Payable
Issued installment notes for cash.
Interest Expense
Notes Payable
Cash
Paid principal and interest on installment
notes.

PE 14–8A
a.

Number of times interest charges earned:
$3,200,000 + $320,000 = 11.0
2014:
$320,000
2013:

b.

$3,600,000 + $300,000 = 13.0
$300,000

The number of times interest charges are earned has decreased from 13.0 in 2013
to 11.0 in 2014. Although the company has adequate earnings to pay interest, the
decline in this ratio may cause concern among debtholders.

PE 14–8B
a.

Number of times interest charges earned:
$5,544,000 + $440,000 = 13.6
2014:
$440,000
2013:

b.

$4,400,000 + $400,000 = 12.0
$400,000

The number of times interest charges are earned has increased from 12.0 in 2013 to
13.6 in 2014. The increase in this ratio increases debtholders’ confidence in the
company’s ability to make its interest payments.


EXERCISES
Ex. 14–1

a.

Rhett
Co.
Earnings before bond interest and income tax…………………………………
Bond interest…………………………………………………………………………
Balance………………………………………………………………………………
Income tax……………………………………………………………………………
Net income……………………………………………………………………………
Dividends on preferred stock……………………………………………………
Earnings available for common stock…………………………………………
Shares of common stock outstanding……………………………………………
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……………………………………………
Shares of common stock outstanding…………………………………………
Earnings per share on common stock…………………………………………

c.

Earnings before bond interest and income tax………………………………

Bond interest…………………………………………………………………………
Balance…………………………………………………………………………………
Income tax……………………………………………………………………………
Net income……………………………………………………………………………
Dividends on preferred stock………………………………………………………
Earnings available for common stock……………………………………………
Shares of common stock outstanding…………………………………………
Earnings per share on common stock…………………………………………

Ex. 14–2
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 do 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 do not.


Ex. 14–3
Nike’s major source of financing is common stock. It has relatively little long-term debt
compared to stockholders’ equity.

Ex. 14–4
The bonds were selling at a premium. This is indicated by the selling price of
115.948, which is stated as a percentage of the face amount and is more than par
(100%). The market rate of interest for similar quality bonds was lower than 7.25%,
and this is why the bonds were selling at a premium.

Ex. 14–5
Apr.

1

Cash
Bonds Paya

Oct.

1

Interest Expen
Cash

Dec.

31

Interest Expen
Interest Pay

* $7,500,000 × 10% × 3/12

Ex. 14–6
a.

1.

Cash
Discount on Bonds Payable
Bonds Payable

2.

Interest Expense
Cash

3.

Interest Expense
Cash

4.

Interest Expense
Discount on Bonds Payable


Ex. 14–6 (Concluded)
b.

Annual interest paid…………………………………………………………………
Plus discount amortized…………………………………………………………
Interest expense for first year……………………………………………………

c.

The bonds sell for less than their face amount because the market rate of
interest is greater than the contract rate of interest. Investors are not willing to
pay the full face amount for bonds that pay a lower contract rate of interest than
the rate they could earn on similar bonds (market rate).

Ex. 14–7
a.

Cash
Premium on Bonds Payable
Bonds Payable

b.

Interest Expense
Premium on Bonds Payable*
Cash**
* $2,842,560 ÷ 20 semiannual payments
** $20,000,000 × 9% × 6/12

c.

The bonds sell for more than their face amount because the market rate of
interest is less than the contract rate of interest. Investors are willing to pay
more for bonds that pay a higher rate of interest (contract rate) than the rate
they could earn on similar bonds (market rate).

Ex. 14–8
2014
Apr.

1

Cash
Bonds Paya

Oct.

1

Interest Expen
Cash

2018
Oct.

1

Bonds Payable
Loss on Redem
Cash*

* $40,000,000 × 1.04


Ex. 14–9
2014
Mar.

1

Cash
Bonds Paya

Sept.

1

Interest Expen
Cash

2020
Sept.

1

Bonds Payable
Gain on Re
Cash*

* $30,000,000 × 0.98

Ex. 14–10 a.
1.

Cash
Notes Payable

2.

Interest Expense*
Notes Payable
Cash
* $50,000 × 0.05

b.

Notes payable are reported as liabilities on the balance sheet. The portion of the
note payable that is due within one year is reported as a current liability. The
remaining portion of the note payable that is not due within one year is reported
as a long-term liability. For this company, the current and noncurrent portions
of the note payable would be reported as follows:


Ex. 14–10 (Concluded)
Current liabilities:
Notes payable*………………………………………………………………………

$ 7,719

* The principal repayment portion of the next installment payment. See computation below.
Noncurrent liabilities:
Notes payable**……………………………………………………………………
** Original note payable……………………………………………………………

$34,930

$50,000

Less principal repayment from year 1………………………………………
Note payable balance at the end of year 1…………………………………
Annual payment on note………………………………………………………
Second year interest payment ($42,649 × 0.05)……………………………
Principal repayment portion of next installment…………………………
Note payable balance at the end of year 1…………………………………

Current portion of note payable (due within one year)…………………
Noncurrent portion of note payable…………………………………………

Ex. 14–11
2014
Jan.

1

Cash
Notes Paya

Dec.

31

Interest Expen
Notes Payable
Cash

2017
Dec.

31

Interest Expen
Notes Payable
Cash

*$46,813 – $10,665

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Ex. 14–12
Amortization of Installment Notes

a.

For the
Year
Ending
Dec. 31, 2014
Dec. 31, 2015
Dec. 31, 2016
Dec. 31, 2017

b.

c.

2014
Jan.

1

Cash
Notes

Dec.

31

Interest
Notes
Cash

2015
Dec.

31

Interest
Notes
Cash

2016
Dec.

31

Interest
Notes
Cash

2017
Dec.

31

Interest
Notes
Cash

Interest expense of $7,500 would be reported on the income statement.


Ex. 14–13
1.

The significant loss on redemption of the Simmons Industries bonds should be
reported in the Other Income and Expense section of the income statement,
rather than as an extraordinary loss.

2.

The Hunter Corporation bonds outstanding at the end of the current year
should be reported as a current liability on the balance sheet because they
mature within one year.

Ex. 14–14
a.

Number of times interest charges earned:
$745,000,000 + $167,000,000
Current year:
$167,000,000
Preceding year:

b.

$164,000,000 + $186,000,000
$186,000,000

= 5.5

= 1.9

The number of times interest charges are earned has increased from 1.9 in the
prior year to 5.5 in the current year. Although Southwest Airlines had enough
earnings to pay interest in the preceding year, the improvement in this ratio will
be welcomed by the debtholders.

Ex. 14–15
a.

Number of times interest charges earned:
$310,500,000 + $13,500,000
2014:
$13,500,000
2013:

b.

$432,000,000 + $16,000,000
$16,000,000

= 24.0

= 28.0

The number of times interest charges are earned has decreased from 28.0 in 2013
to 24.0 in 2014. Although Loomis has adequate earnings to pay interest, the
decline in this ratio may cause concern among debtholders.


Ex. 14–16
a.

b.

Number of times interest charges earned:
2014:

$3,500,000 + $5,000,000
$5,000,000

= 1.7

2013:

$6,000,000 + $5,000,000
$5,000,000

= 2.2

The number of times interest charges are earned has decreased from 2.2 in 2013
to 1.7 in 2014. Although the company has enough earnings to pay interest in

2014, the deterioration in this ratio is a cause for concern to debtholders.

Appendix 1 Ex. 14–17
$1,000,000 × 0.75131 = $751,310
Cash on hand today can be invested to earn income. If $751,315 is invested at
10%, it will be worth $1,000,000 at the end of three years.

Appendix 1 Ex. 14–18
a.

b.

First Year:
$200,000 × 0.93458 =
Second Year:
$200,000 × 0.87344 =
Third Year:
$200,000 × 0.81630 =
Fourth Year:
$200,000 × 0.76290 =
Total present value

$186,916
$174,688
$163,260
$152,580
$677,444

$200,000 × 3.38721 = $677,442*
*$2 difference between a. and b. is due to rounding.

c.

Cash on hand today can be invested to earn income. If each of the $200,000
of cash receipts is invested at 7%, it will be worth $677,444 at the end of four
years.

Appendix 1 Ex. 14–19
$7,500,000 × 7.02358 = $52,676,850


Appendix 1 Ex. 14–20
No. The present value of your winnings using an interest rate of 12% is $42,376,650
($7,500,000 × 5.65022), which is less than the present value of your winnings using
an interest rate of 7% ($52,676,865; see Appendix 1 Ex. 14–19). This is because
the winnings are affected by the higher interest rate.

Appendix 1 Ex. 14–21
Present value of $1 for 10 semiannual
periods at 4.5% semiannual rate……………………………
Face amount of bonds…………………………………………
Present value of an annuity of $1
for 10 periods at 4.5%………………………………………
Semiannual interest payment…………………………………

$16,098,250
7.91272
× $

875,000*

Total present value (proceeds)………………………………

6,923,630
$23,021,880

* $25,000,000 × 3.5%

Appendix 1 Ex. 14–22
Present value of $1 for 8 semiannual
periods at 4.0% semiannual rate……………………………
Face amount of bonds…………………………………………

0.73069
× $30,000,000

Present value of an annuity of $1
6.73274
for 8 semiannual periods at 4.0% semiannual rate………
Semiannual interest payment………………………………… × $ 1,500,000*
Total present value (proceeds)………………………………
* $30,000,000 × 5%
Appendix 2 Ex. 14–23
a.

2.

1.

Cash

Discount on Bonds Payable
Bonds Payable
Interest Expense*
Discount on Bonds Payable
Cash**
* $43,495,895 × 4.5%
** $50,000,000 × 3.5%

$21,920,700

10,099,110
$32,019,810


CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Appendix 2 Ex. 14–23 (Concluded)
3.

Interest Expense*
Discount on Bonds Payable
Cash
* ($43,495,895 + $207,315) × 4.5%

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 20 semiannual

periods at 4.5% semiannual rate………………………………
Face amount of bonds……………………………………………
Present value of annuity of $1
for 20 semiannual periods at 4.5% semiannual rate………
Semiannual interest payment…………………………………… ×

$20,732,000
13.00794
$ 1,750,000 *

Total present value (proceeds)…………………………………
* $50,000,000 × 3.5%
b.

Annual interest paid………………………………………………
Plus discount amortized*…………………………………………
Interest expense for first year……………………………………
* $207,315 + $216,644

c.

The bonds sell for less than their face amount because the market rate of
interest is greater than the contract rate of interest. Investors are not
willing to pay the full face amount for bonds that pay a lower contract rate
of interest than the rate they could earn on similar bonds (market rate).

Appendix 2 Ex. 14–24
a.

2.

1.

Cash
Premium on Bonds Payable
Bonds Payable
Interest Expense*
Premium on Bonds Payable
Cash**
* $23,829,684 × 3.5%
** $22,000,000 × 4.5%

3.

Interest Expense*
Premium on Bonds Payable
Cash
* ($23,829,684 – $155,961) × 3.5%

22,763,895
$43,495,895


Appendix 2 Ex. 14–24 (Concluded)
b.

Annual interest paid………………………………………
Less premium amortized*………………………………
Interest expense for first year…………………………
* $155,961 + $161,420

c.

The bonds sell for more than their face amount because the market rate of
interest is less than the contract rate of interest. Investors are willing to pay
more for bonds that pay a higher rate of interest (contract rate) than the rate
they could earn on similar bonds (market rate).

Appendix 1 and 2 Ex. 14–25
a.

b.

c.

Present value of $1 for 10 semiannual
periods at 5% semiannual rate………………………
Face amount of bonds……………………………………

0.61391
× $35,000,000

$21,486,850

Present value of an annuity of $1 for 10
7.72173
semiannual periods at 5% semiannual rate…………
×
$ 2,100,000
Semiannual interest payment……………………………

Proceeds of bond sale……………………………………

16,215,633
$37,702,483

First semiannual interest payment……………………
5% of carrying amount of $37,702,483…………………
Premium amortized…………………………………………

$ 2,100,000
1,885,124

Second semiannual interest payment…………………
5% of carrying amount of $37,487,607*…………………
Premium amortized…………………………………………

$ 2,100,000
1,874,380

$

$

* $37,702,483 – $214,876
d.

Annual interest paid………………………………………
Less premium amortized*…………………………………
Interest expense for first year……………………………
* $214,876 + $225,620

214,876

225,620


CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Appendix 1 and 2 Ex. 14–26
a.

Present value of $1 for 10 semiannual
0.55839
periods at 6.0% semiannual rate……………………………
Face amount of bonds…………………………………………… × $80,000,000
Present value of an annuity of $1 for 10 semiannual
periods at 6.0% semiannual rate……………………………
Semiannual interest payment…………………………………

7.36009
× $ 3,600,000*

Proceeds of bond sale……………………………………………
* $80,000,000 × 4.5%
b.

6.0% of carrying amount of $71,167,524……………………
First semiannual interest payment……………………………

Discount amortized………………………………………………

c.

6.0% of carrying amount of $71,837,575*……………………
Second semiannual interest payment…………………………
Discount amortized………………………………………………
*

d.

$71,167,524 + $670,051

Annual interest paid……………………………………………
Plus discount amortized*………………………………………
Interest expense for first year…………………………………
*

$670,051 + $710,255

$44,671,200

26,496,324
$71,167,524


PROBLEMS
Prob. 14–1A
1.
Earnings before interest and income tax……

Deduct interest on bonds………………………
Income before income tax……………………
Deduct income tax………………………………
Net income………………………………………
Dividends on preferred stock…………………
Available for dividends on common stock… Shares of common stock outstanding………
Earnings per share on common stock………
2.
Earnings before interest and income tax……
Deduct interest on bonds………………………
Income before income tax………………………
Deduct income tax………………………………
Net income…………………………………………
Dividends on preferred stock…………………
Available for dividends on common stock… Shares of common stock outstanding………
Earnings per share on common stock………
3.

The principal advantage of Plan 1 is that it involves only the issuance of common
stock, which does not require a periodic interest payment or return of principal,
and a payment of preferred dividends is not required. It is also more attractive to
common shareholders than is Plan 2 or 3 if earnings before interest and income tax
is $1,050,000. In this case, it has the largest EPS ($0.35). The principal disadvantage of
Plan 1 is that, if earnings before interest and income tax is $2,100,000, it offers the
lowest EPS ($0.70) on common stock.
The principal advantage of Plan 3 is that less investment would need to be made by
common shareholders. Also, it offers the largest EPS ($1.44) if earnings before interest
and income tax is $2,100,000. Its principal disadvantage is that the bonds carry a fixed
annual interest charge and require the payment of principal. It also requires a dividend
payment to preferred stockholders before a common dividend can be paid. Finally,

Plan 3 provides the lowest EPS ($0.04) if earnings before interest and income tax is
$1,050,000.
Plan 2 provides a middle ground in terms of the advantages and disadvantages
described in the preceding paragraphs for Plans 1 and 3.


Prob. 14–2A
1.

2.

Cash
Discount on Bonds Payable
Bonds Payable
Interest Expense
Discount on Bonds Payable*
Cash

a.

*

$8,579,095 ÷ 40 semiannual payments

Interest Expense
Discount on Bonds Payable*
Cash

b.

*

$8,579,095 ÷ 40 semiannual payments

3.

$4,714,477

4.

Yes. Investors will not be willing to pay the face amount of the bonds when the
interest payments they will receive from the bonds are less than the amount of
interest that they could receive from investing in other bonds.

5.

Present value of $1 for 40 semiannual
periods at 5.0% semiannual rate…………………………
Face amount of bonds………………………………………
Present value of annuity of $1 for 40
semiannual periods at 5.0% semiannual rate…………
Semiannual interest payment………………………………
Proceeds of bond issue……………………………………

0.14205
× $100,000,000

$14,205,000

17.15909

4,500,000

77,215,905

×

$

$91,420,905

14-19
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Prob. 14–3A
1.

2.

Cash
Premium on Bonds Payable
Bonds Payable
Interest Expense
Premium on Bonds Payable*
Cash

a.

*

Interest Expense
Premium on Bonds Payable*
Cash

b.

*
3.

$41,403,720 ÷ 40 seminannual payments

$41,403,720 ÷ 40 semiannual payments

$7,964,907

4.

Yes. Investors will be willing to pay more than the face amount of the bonds
when the interest payments they will receive from the bonds exceed the amount
of interest that they could receive from investing in other bonds.

5.

Present value of $1 for 40 semiannual
0.17193
periods at 4.5% semiannual rate………………………………
Face amount of bonds…………………………………………… × $150,000,000

$ 25,789,500

Present value of annuity of $1
for 40 semiannual periods at 4.5% semiannual rate………
Semiannual interest payment…………………………………… × $
Proceeds of bond issue…………………………………………

165,614,220
$191,403,720

18.40158
9,000,000


Prob. 14–4A
1.

2014
July

1

Oct.

1

Dec.

31

31

31

31
2015
June

30

Sept.

30

Dec.

31

31

31

31
2016
June

* $88,000,000 × 0.97

30


Prob. 14–4A (Concluded)

2016
Sept.

2.
3.

30

Interest E
Interest P
Notes Pay
Cash
a.
b.

Initial carrying amount of bonds……………………………………………………
Discount amortized on December 31, 2014……………………………………
Discount amortized on December 31, 2015………………………………………
Carrying amount of bonds, December 31, 2015…………………………………


Appendix 1 and 2 Prob. 14–5A
1.

2.

2014
July

a.

1

2014
Dec.

31

*$91,420,905 × 5.0%

2015
June

b.

30

*($91,420,905 + $71,045) × 5.0%

3.

$4,571,045

Appendix 1 and 2 Prob. 14–6A
1.

2.

2014
July

a.

2014
Dec.

1

31

*$191,403,720 × 4.5%

b.

2015
June

*($191,403,720 – $386,833) × 4.5%

3.

$8,613,167

30


Prob. 14–1B
1.
Earnings before interest and income tax………
Deduct interest on bonds…………………………

Income before income tax…………………………
Deduct income tax……………………………………
Net income……………………………………………
Dividends on preferred stock……………………
Available for dividends on common stock……
Shares of common stock outstanding……………
Earnings per share on common stock……………
2.
Earnings before interest and income tax………
Deduct interest on bonds…………………………
Income before income tax…………………………
Deduct income tax…………………………………
Net income……………………………………………
Dividends on preferred stock………………………
Available for dividends on common stock………
Shares of common stock outstanding…………
Earnings per share on common stock…………
3.

The principal advantage of Plan 1 is that it involves only the issuance of common
stock, which does not require a periodic interest payment or return of principal,
and a payment of preferred dividends is not required. It is also more attractive to
common shareholders than is Plan 2 or 3 if earnings before interest and income
tax is $6,000,000. In this case, it has the largest EPS ($0.90). The principal
disadvantage of Plan 1 is that, if earnings before interest and income tax is
$10,000,000, it offers the lowest EPS ($1.50) on common stock.
The principal advantage of Plan 3 is that less investment would need to be made
by common shareholders. Also, it offers the largest EPS ($2.84) if earnings before
interest and income tax is $10,000,000. Its principal disadvantage is that the bonds
carry a fixed annual interest charge and require the payment of principal. It also

requires a dividend payment to preferred stockholders before a common dividend
can be paid. Finally, Plan 3 provides the lowest EPS ($0.44) if earnings before interest
and income tax is $6,000,000.
Plan 2 provides a middle ground in terms of the advantages and disadvantages
described in the preceding paragraphs for Plans 1 and 3.


Prob. 14–2B
1.

2.

Cash
Discount on Bonds Payable
Bonds Payable
a.

Interest Expense
Discount on Bonds Payable*
Cash
*$3,690,764 ÷ 40 semiannual payments

b.

Interest Expense
Discount on Bonds Payable*
Cash
*$3,690,764 ÷ 40 semiannual payments

3.

$2,392,269

4.

Yes. Investors will not be willing to pay the face amount of the bonds when the
interest payments they will receive from the bonds are less than the amount of
interest that they could receive from investing in other bonds.

5.

Present value of $1 for 40 semiannual
periods at 5.5% semiannual rate…………………………………
0.11746
Face amount of bonds…………………………………………… × $46,000,000

$ 5,403,160

Present value of an annuity of $1
for 40 semiannual periods at 5.5% semiannual rate………
16.04612
Semiannual interest payment………………………………………× $ 2,300,000
Proceeds of bond issue……………………………………………

36,906,076
$42,309,236