User Account

All Pages

Adjustments for changes in fair value

Assignment Help Financial Management
Reference no: EM131007360

On January 1, 2011, Labtech Circuits borrowed $100,000 from First Bank by issuing a three-year, 8% note, payable on December 31, 2013. Labtech wanted to hedge the risk that general interest rates will decline, causing the fair value of its debt to increase. Therefore, Labtech entered into a three-year interest rate swap agreement on January 1, 2011, and designated the swap as a fair value hedge. The agreement called for the company to receive payment based on an 8% fixed interest rate on a notional amount of $100,000 and to pay interest based on a floating interest rate tied to LIBOR. The contract called for cash settlement of the net interest amount on December 31 of each year.
Floating (LIBOR) settlement rates were 8% at inception and 9%, 7%, and 7% at the end of 2011, 2012, and 2013, respectively. The fair values of the swap are quotes obtained from a derivatives dealer. Those quotes and the fair values of the note are as follows:

Required:

Use the extended method demonstrated in Illustration A-2.

1. Calculate the net cash settlement at the end of 2011, 2012, and 2013.

2. Prepare the journal entries during 2011 to record the issuance of the note, interest, and necessary adjustments for changes in fair value.A-19

3. Prepare the journal entries during 2012 to record interest, net cash interest settlement for the interest rate swap, and necessary adjustments for changes in fair value.

4. Prepare the journal entries during 2013 to record interest, net cash interest settlement for the interest rate swap, necessary adjustments for changes in fair value, and repayment of the debt.

5. Calculate the carrying values of both the swap account and the note in each of the three years.

6. Calculate the net effect on earnings of the hedging arrangement in each of the three years. (Ignore income taxes.)

7. Suppose the fair value of the note at December 31, 2011, had been $97,000 rather than $98,241 with the additional decline in fair value due to investors' perceptions that the creditworthiness of Labtech was worsening. How would that affect your entries to record changes in the fair values?

Reference no: EM131007360

Questions Cloud

Explain the concept of a positive externality : Explain how competition in markets can often provide incentives for the invention of new technology. Using the ideas of social benefit and privaate benefit, explain the concept of a positive externality. Why does new technology have positive external..
Determine the arc price elasticity of demand for tickets : The current price charged by a local movie theater is $8 per ticket. At the current ticket price, the theater typically sells 300 tickets per showing. If the theater raises ticket prices to $9, the theater will sell 270 tickets. Assuming that the dem..
Deep web assessment exercise : Deep web assessment exercise IS 301( business writing class) Using business source premier, conduct a keyword search for an article about outsourcing. Browse the result page and list some of the Subject term(s) which could be used to focus your searc..
Determine the alternative that is economically best : For the cash flows shown, use an annual worth comparison and an interest rate of 10% per year. Determine the alternative that is economically best. Determine the first cost required for each of the two alternaqtives not selected in (a) so that all al..
Adjustments for changes in fair value : Prepare the journal entries during 2012 to record interest, net cash interest settlement for the interest rate swap, and necessary adjustments for changes in fair value.
Subsequent withdrawals increase at the rate : What is the amount of 10 equal annual deposits that can provide five annual withdrawals, when a first withdrawal of $15,000 is made at the end of year 11 and subsequent withdrawals increase at the rate of 8% per year over the previous years withdrawa..
What is the slope of the inverse demand : Suppose the demand for tablets is given Q = 2000 - 10 P. Where Q is the quantity demanded and P is the price of tablets. Plot the demand curve. (Price in the vertical and quantity in the horizontal axis) What is the inverse demand?What is the slope o..
Announced that they were going to reduce the income tax : If the government announced that they were going to reduce the income tax next year, financed by finding a large and previously-unknown warehouse of real goods. What would happen to labor? To consumption? If the government announced they were going t..
How long will the company continue to manufacture the phone : The company is planning on withdrawing this model when annual sales reaches 60 000 cell phones. If current annual sales of these phones are 100 000. find S(t). How long will the company continue to manufacture this phone?

Reviews

Write a Review

Financial Management Questions & Answers

  Equity used is from reinvested earnings

MM Entreprises stock trades for $52.50 per share. It is expected to pay $2.50 dividend at yearend, and the dividend is expected to grow at a constant rate of 5.50% a year. The before tac cost of debt is 7.50% and the tax rate is 40%. The target capit..

  Using the adjusted present value method

MVP Inc has produced rodeo supplies for over 20 years. The company currently has a debt-equity ratio of 50% and is in the 40% tax bracket. The required return on the firm’s levered equity is 16%. MVOP is planning to expand its production capacity. Us..

  In defining demand and supply

In defining demand and supply, why do you think economists focus on price while holding constant other factors that might have an impact on the behavior of buyers and sellers?

  Probability distributions of expected future returns

Stocks X and Y have the following probability distributions of expected future returns: Probability X Y 0.1 -14% -35% 0.2 3 0 0.3 16 22 0.3 22 27 0.1 39 40. Calculate the expected rate of return, rY, for Stock Y (rX = 14.50%.)

  What is the minimum rate of return

You bought a stock last year that grows by 10% every year. You decide that you will both hold onto that stock for another year and sell it, or you will sell it now and buy a different stock. If you are taxed 40% on half (50%) of the profit you make, ..

  What interest rate would the investment

Stanley has $2,400 that he is looking to invest. His brother approached him with an investment opportunity that could give Patrick $4,800 in 4 years. What interest rate would the investment have to yield in order for Stanley’s brother to deliver on h..

  Proposed cost-saving device has an installed cost

A proposed cost-saving device has an installed cost of $680,000. The device will be used in a five-year project but is classified as three-year MACRS property for tax purposes. The device has an estimated Year 5 salvage value of $75,000. What level o..

  What was the expected level of inflation

The risk-free rate on T-bills recently was 1.23%. If the real rate of interest is estimated to be 0.80%, what was the expected level of inflation?

  What would be the increase in value of company after loan

The Maxwell Company is financed entirely with equity. The company is considering a loan of $1.83 million. The loan will be repaid in equal instalments over the next two years, and it has an interest rate of 8 percent. The company’s tax rate is 35 per..

  Value of a european call option with an exercise price

A stock currently sells for $50. In six months, it will either rise to $55 or decline to $45. The risk-free interest rate is 6% per year. Find the value of a European call option with an exercise price of $50. Find the value of a European put option ..

  What was the restructuring accrual associated

Cranberry Chemical recorded pre tax restructuring charges of $1378 million in 2014. The charges consisted of asset write-downs of $908 million, costs associated with exit or disposal activities of $132 million, and employee severance costs of $338 mi..

  What is the current common stock value

What is the current common stock value for each of the companies listed walt disney ,oracle corporation ford motor company. what is the current common stock value? how many shares are issued?

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

Submit Assignment

Academics

Major Subjects

Majors

Get In Touch

whatsapp: +1-415-670-9521

Phone: +1-415-670-9521

Email: [email protected]

TERMS & POLICIES

HELP & SUPPORT

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd