General Host; Accounting for a Bond Refunding

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Year| 5% Bonds| 11% Bonds|
1975| $1.695| $2.233|
1976| $1.695| $2.233|
1977| $1.695| $2.233|
1978| $1.695| $2.233|
1979| $1.695| $2.233|
1980| $1.695| $2.233|
1981| $1.695| $2.233|
1982| $1.695| $2.233|
1983| $1.695| $2.233|
1984| $1.695| $2.233|
1985| $1.695| $2.233|
1986| $1.695| $2.233|
1987| $1.695| $2.233|
1988| $35.595*| $22.533*|
*Face value and interest
(In millions)
1. $33.9 million (Face value) X 5% (Coupon rate) = $1,695,000

2. $20.3 million (Face value) X 11% (Coupon rate) = $2,233,000

3. Assume that 11% is the market rate of interest in on January 1, 1975. Compute the present value at January 1, 1975 of all payments that will be made on the 5% bonds if they are not retired.

Principle $33.9 million, Interest $1.695 million, N 14, Rate 11% => $19,698,886 ≈ $19.7 million Present value of bonds: $19.7 million

4. Again assuming that 11% is the market rate, compute the present value at January 1, 1975 of the payments that General Host will make on the 11% bonds if they replace the 5% bonds.

Principle $20.3 million, Interest $2.233 million, N 14, Rate 11% => $20,300,000 Present value of bonds: $20.3 million

5. Prepare the journal entry to record the exchange.

Bonds payable (old)$33.9 million
Bonds payable (new)$20.3 million
Gain on early extinguishment$13.6 million
II. Evaluating the exchange: Considering only the work you have done so far, and not considering the conversion feature: 1. What are the costs and benefits of the exchange for General Host’s bondholders?

Bondholders can get costs and benefits of $538,000 from increasing annual interest.

2. What are the costs and benefits of the exchange for General Host and its stockholders?

General Host and stockholders can get costs and benefits of $13.6 million from exchange bonds at a reduced price. III. The conversion feature.
The article mentions that the "conversion" price was reduced from $27/share to $16/share. This means that the bondholders may trade their bonds for common shares at some point in the future at the specified prices based on the par value of the converted bonds.

1. Before the exchange, the entire 5% bond issue could have been converted into how many shares?

$33.9 million (principle)/$27 (per share) = 1,255,556 shares

2. After the exchange, the entire 11% bond issue could have been converted into how many shares?

$20.3 million (principle)/@16 (per share) = 1,268,750 shares

3. Why do you think the conversion price was changed?

Yes, the conversion price was changed because a number of shares were increased about 13,194 after conversion and this means the reduced price ($16) is lower than the actual reduced value. Therefore the share price has to be $16.17*. *Calculation => $33.9 million : $27 = $20.3 million : X

X = $16.1681 ≈ $16.17

4. With respect to the conversion feature only, who is better off after the exchange, the bondholders or General Host and its stockholders?

In conversion feature, the bondholders have gain after the exchange, because bondholders have 13,194 more shares. If General Host issued stocks with an even conversion rate, the number of shares after exchange have to be same as 1,255,556. However, by simple calculation, the bondholders get more principle value of $356,250*. *Differences between original face value and conversion value. $27 (per share) X 1,268,750 (number of shares) = $34,256,250. Original face value: $33,900,000

IV. A Cash Deal
The author states that "It doesn't mean that General Host paid off its debt at less than 100 cents on the dollar, and thereby earned a substantial discount." He means that no cash changed hands in this transaction. Now look at what would have happened if this had been a cash deal. Suppose that instead of offering the bond exchange, General Host had issued the new 11% bonds for cash...
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