Mgm Harvard Business School Accounting Case

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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 (Issued) – 51973(Treasury) i.e. Shares outstanding = 5,321,295 shares
Net Income in 1974 (excluding interest expense) = $809,000 (assumed same as 1973)

Pretax net income = $809,000/.52 = $1,555,769.23

From the previous table interest expense in the first year = sum of first two payments

= $501.5 +$502.4 = $1,003.9 (in thousands)
So 1974 pretax net income = 1,555,769 – 1,003,900 = $551,869 After tax net income = $551,869* (1-0.48) = $286,972

Earnings per share = $286,972/5,321,295 = 5.4 c/share

4.The Face value of the 5% convertible subordinated debentures = $30,010 (from liabilities section of the balance sheet)

We know that the effective interest rate is 12.357%
One bond of $650 principle 10% subordinated debentures provides a monthly payment of 650*0.1/2 = $32.5 payment per period

# of outstanding $1000 in face value of 5% convertibles
= $30,010/$1,000 = 30.01 (in thousands)

So 30.01 thousand subordinated debentures with $650 principle and delivering10% are being offered whose present value can be calculated as

30.01* [PV($32.5 per period for 40 periods) + PV ($650 after 40 periods) both at a EIR of 12.357%]
= 30* 537.3 = $16,662 (in thousands)

Based on the above, the journal entry to record to exchange of 10% subordinated debentures for old 5% convertible subordinated debentures is given below (all amounts in thousands)

Dr 5% convertible Subordinated Debentures Due 1993$30,010
Cr 10% Subordinated Debentures Due 1994$16,662
Cr Gain on bond retirement$13,348

5.The following table shows the bond repayment schedule for the new 10% debentures issued. The face value is $16,662. This means the discount that is applied is $6.5/$23 * $650 = $183.7 per bond. This means Face value = $16,662

Discount = 183.7/650 * 16,662 = $4,709
Based on the above the following table (TABLE 2) shows the repayment series.

The following table (TABLE 3) shows the bond repayment schedule for the existing 5% bonds. Note that 2...
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