Mgm Harvard Business School Accounting Case
1. Effective Interest Rate on the new 10% debentures = 14.318%
For the 10% debentures, the market value of 1 share is $19.5 (given)
The equivalent of this is a cash offer of $3/share and a 10% subordinated debenture of face value of $23.
So the PV (10% subordinated debentures with FV $23) = $19.5 - $3 = $16.5
The effective interest rate (yield) on the above is that interest rate ‘r’ that gives the following
PV (Per period payment of ($23*5% i.e. $1.15) over 40 periods @ r)
+ PV ($23 paid 40 periods hence with a return of r)
$16.5
1.15*(1 – (1/(1+r)^40))/r + 23/(1+r)^40 = 16.5
Solving for r in the above equation we get 14.318% as the effective interest rate.
Similarly, Effective Interest Rate on the old 5% debenture = 12.53%
The par value of these debentures = $1000
Per period payment = 100*05/2 = $25
Given that the market value of the 5% debenture as of this date is $458.75
PV (Per period payment of $25 over 40 periods @ r)
+ PV ($1000 paid 40 periods hence with a return of r)
$458.75
Solving for r in the above equation we get 12.357% as the effective interest rate.
2. The journal entry to retire 10% of the issued shares under the first exchange offer is as follows.
Cost to acquire 1 share = $19.5
# shares acquired = 10% = (5970298 -51973)* 10% = 591,833
Total value of shares acquired = 591,833 * 19.5 = 11,540,743
Cash payment = $3/share = 3*591,833 = $1,775,499
Remaining (i.e. Bonds payable) = $9,765,244
Dr Common Stock, no par value $11,541 (10% of CS @$19.5/share) Cr Bonds payable $9,765 (plug)
Cr Cash $1,776 ($3/share * 597.0298 thousand shares)
Note that the $9765 includes the discount applied to the face value of the bond. The value of this discount is $9,765*6.5/23 = $2,760, Face value = $7,005
The following table (TABLE 1) shows the bond repayment schedule.
3. The earnings per share from continued operations for 1974 is calculated as follows.
Shares outstanding = 5,970,298*0.9
For the 10% debentures, the market value of 1 share is $19.5 (given)
The equivalent of this is a cash offer of $3/share and a 10% subordinated debenture of face value of $23.
So the PV (10% subordinated debentures with FV $23) = $19.5 - $3 = $16.5
The effective interest rate (yield) on the above is that interest rate ‘r’ that gives the following
PV (Per period payment of ($23*5% i.e. $1.15) over 40 periods @ r)
+ PV ($23 paid 40 periods hence with a return of r)
$16.5
1.15*(1 – (1/(1+r)^40))/r + 23/(1+r)^40 = 16.5
Solving for r in the above equation we get 14.318% as the effective interest rate.
Similarly, Effective Interest Rate on the old 5% debenture = 12.53%
The par value of these debentures = $1000
Per period payment = 100*05/2 = $25
Given that the market value of the 5% debenture as of this date is $458.75
PV (Per period payment of $25 over 40 periods @ r)
+ PV ($1000 paid 40 periods hence with a return of r)
$458.75
Solving for r in the above equation we get 12.357% as the effective interest rate.
2. The journal entry to retire 10% of the issued shares under the first exchange offer is as follows.
Cost to acquire 1 share = $19.5
# shares acquired = 10% = (5970298 -51973)* 10% = 591,833
Total value of shares acquired = 591,833 * 19.5 = 11,540,743
Cash payment = $3/share = 3*591,833 = $1,775,499
Remaining (i.e. Bonds payable) = $9,765,244
Dr Common Stock, no par value $11,541 (10% of CS @$19.5/share) Cr Bonds payable $9,765 (plug)
Cr Cash $1,776 ($3/share * 597.0298 thousand shares)
Note that the $9765 includes the discount applied to the face value of the bond. The value of this discount is $9,765*6.5/23 = $2,760, Face value = $7,005
The following table (TABLE 1) shows the bond repayment schedule.
3. The earnings per share from continued operations for 1974 is calculated as follows.
Shares outstanding = 5,970,298*0.9