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Nordbock Inc. reports the following outstanding bond issue on its December 31, 20Y1, balance sheet: $1,000,000, 7%, 10-year bonds that pay interest semiannually. The bonds have been outstanding for five years and were originally issued at face amount. The company is considering redeeming these bonds on January 1, 20Y2, at 103 and issuing new $1,000,000, 5%, five-year bonds at their face amount. These bonds would pay interest semiannually on June 30 and December 31. Write a brief memo to Liz Nolan, the chief financial officer, discussing the costs of redeeming the existing bonds, the proceeds from issuing the new bonds, and whether this is a good financial decision.

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Financial Accounting

15th Edition
Carl Warren + 2 others
Publisher: Cengage Learning
ISBN: 9781337272124

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BuyFindarrow_forward

Financial Accounting

15th Edition
Carl Warren + 2 others
Publisher: Cengage Learning
ISBN: 9781337272124
Chapter 14, Problem 3CP
Textbook Problem
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Nordbock Inc. reports the following outstanding bond issue on its December 31, 20Y1, balance sheet:

$1,000,000, 7%, 10-year bonds that pay interest semiannually.

The bonds have been outstanding for five years and were originally issued at face amount. The company is considering redeeming these bonds on January 1, 20Y2, at 103 and issuing new $1,000,000, 5%, five-year bonds at their face amount. These bonds would pay interest semiannually on June 30 and December 31.

Chapter 14, Problem 3CP, Nordbock Inc. reports the following outstanding bond issue on its December 31, 20Y1, balance sheet: Write a brief memo to Liz Nolan, the chief financial officer, discussing the costs of redeeming the existing bonds, the proceeds from issuing the new bonds, and whether this is a good financial decision.

To determine

Draft a memo to LN, chief financial officer of Incorporation N, explaining the financial issues related with redeeming of the bonds and issue of new bonds, and whether the redemption and issue is correct financial decision or not.

Explanation of Solution

Bond investment: Bond investments are debt securities which pay a fixed interest revenue to the investor.

Prepare a memo to the LN, chief financial officer (CFO) of Incorporation N, explaining the financial issues related with redeeming of the bonds and issue of new bonds.

MEMO

Date:        February 25, 2018

To:        LN, CFO, Incorporation N

From:        Ms J

Subject:  Redemption old bonds and issue of new bonds

To conclude whether the financial decision is good or not, first the redemption of 7% old bonds should be compared to the new issue of 5% bonds. The following things should be considered:

  • Proceeds from new issue
  • Cost of redeeming old bonds
  • Cost of interest expense of old bonds and new bonds (any interest savings)

The following table shows the interest expense of both the bonds and the interest savings:

Details7% Bonds (Old)5% Bonds (New)
Face value of the bonds$1,000,000$1,000,000
Rate of interest× 7%× 5%
Payment terms (semiannual)× 0.5× 0.5
Semiannual interest expense$35,000$25,000

Table (1)

So, the new issue would save $10,000 ($35,000$25,000) on one semiannual interest period

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Chapter 14 Solutions

Financial Accounting
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