Reference no: EM132590076

On July 1, 2015, ABC Co. issued 10-year, $4,574 million maturity value, 3% coupon bonds when the market rate was 2% for a cash price of $4,994 million. Interest was payable semi-annually on Dec. 31 and June 30. ABC also issued $3,527 million face value, 20-year, zero coupon bonds on July 1, 2017 that mature June 30, 2037 for a cash price of $2,619 million. The effective market interest rate at issuance was 1.5%. ABC repurchased $1,143 million face value coupon bonds on June 30, 2020 for $1,220 million cash (after interest was paid) and $582 million in face value of the zero- coupon bonds on June 30, 2021 for a purchase price of $432 million cash.

NOTES:

Expressing all numbers in millions (for example, the face amounts of the bonds are $4,574 and $3,527, respectively ).
Please answer in complete sentences and show your calculations for numerical answers and journal entries (Round to millions).

Question 1: Show the calculations for how the cash prices were determined for both bond issuances and make the journal entries for each at issuance using discount or premium accounts if applicable. (Do not net in Bond Payable)

Question 2: Create amortization schedules for both bond issuances. Note interest is semi- annual for the coupon bonds and you may assume annual for the zero- coupon bonds. Use the effective interest method.

Question 3: What amount of interest expense for the bonds did ABC report on its income statement in 2019 for each bond separately and in total?

Question 4: Interest expense is deductible on the corporate tax return. Assuming a corporate tax rate of 19% in 2019, how much did ABC save in taxes by deducting the interest expense? What was the after-tax interest cost in 2019?

Question 5: At the end of June 30, 2020, what was the book value of the coupon bonds before the repurchase transaction? At the end of June 30, 2021, what was the book value of the zero-coupon bond before the repurchase transaction? Name the two accounts and balances from the Balance Sheet that combine to determine the book value for each bond.

Question 6: Prepare the journal entry to record the repurchase of some of the debt at the end of 2020 and 2021. [Repurchasing some of the bonds before the maturity date is called "early extinguishment" of the debt. The company makes a payment to the bondholders, who relinquish the bonds and their right to collect the face value at maturity, and the debt is removed from the books. To record the early extinguishment, the company makes a journal entry to remove the appropriate book value and decrease cash by the amount paid to the bondholders. If those two amounts are not equal, a gain or loss is recorded to balance the journal entry. Look at your answer to #5 and note that a portion of each account related to this debt must be removed from the books. The journal entry is analogous to the entry you would use to remove a long-term asset from the books when it is sold.]

Question 7: Why might company managers choose to issue zero-coupon bonds instead of interest-bearing bonds or coupon bonds instead of zero- coupon bonds? Give pros and cons of each. Why might they decide to repurchase some of the bonds before the maturity date? Be sure to consider whether management may choose to repurchase when interest rates are increasing or decreasing (both) and explain why.