Page 623 - Accounting Principles (A Business Perspective)

15. Long-term financing: Bonds

Exercise K What is the present value of a series of semiannual payments of USD 10,000 due at the end of each
six months for the next five years if the market rate of interest is 10 per cent per year and the present value of an
annuity of USD 1 for 10 periods at 5 per cent is 7.72173?

Exercise L Joe Mordino bought a ticket in the Georgia lottery for USD 1, hoping to strike it rich. To his
amazement, he won USD 4,000,000. Payment was to be received in equal amounts at the end of each of the next 20
years. Mordino heard from relatives and friends he had not heard from in years. They all wanted to renew their
relationship with this new millionaire. Federal and state income taxes were going to be about 40 per cent (36 per
cent for federal and 4 per cent for state) on each year's income from the lottery check. The discount rate to use in all
present value calculations is 12 per cent.
a. How much will Mordino actually receive after taxes each year?

b. Is Mordino a multimillionaire according to the present value of his cash inflow after taxes?
c. What is the present value of the net amount the state has to pay out? Remember that the state gets part of the
money back in the form of taxes.
Exercise M After Joe Mordino won USD 4,000,000 in the Georgia lottery, he decided to purchase USD 10,000
of lottery tickets at the end of each year for the next 20 years. He was hoping to hit the lottery again, but he never
did. If the state can earn 12 per cent on ticket revenue received, how much will the annuity of USD 10,000 from
Mordino grow to by the end of 20 years?

Problems
Problem A On 2009 June 1, Economy Auto Parts, Inc., issued USD 180,000 of 10-year, 16 per cent bonds
dated 2009 April 1, at 100. Interest on bonds is payable semiannually on presentation of the appropriate coupon.
All of the bonds are of USD 1,000 denomination. The company's accounting period ends on June 30, with
semiannual statements prepared on December 31 and June 30. The interest payment dates are April 1 and October
1.

All of the first coupons on the bonds are presented to the company's bank and paid on 2009 October 2. All but
two of the second coupons are similarly received and paid on 2010 April 1.
Prepare all necessary journal entries for these transactions through 2010 April 1, including the adjusting entry
needed at 2009 June 30.
Problem B Ecological Water Filtration, Inc., is going to issue USD 400,000 face value of 10 per cent, 15-year
bonds. The bonds are dated 2009 June 30, call for semiannual interest payments, and mature on 2024 June 30.
a. Compute the price investors should offer if they seek a yield of 8 per cent on these bonds. Also, compute the
first six months' interest, assuming the bonds are issued at this price. Use the interest method and calculate all
amounts to the nearest dollar.

b. Repeat part (a), assuming investors seek a yield of 12 per cent.
Problem C On 2009 July 1, South Carolina Table Company issued USD 600,000 face value of 10 per cent, 10-
year bonds. The bonds call for semiannual interest payments and mature on 2019 July 1. The company received
cash of USD 531,180, a price that yields 12 per cent.
Assume that the company's fiscal year ends on March 31. Prepare journal entries (to the nearest dollar) to record
the bond interest expense on 2010 January 1, and the adjustment needed on 2010 March 31, using the interest
method. Calculate all amounts to the nearest dollar.

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