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SERIAL PROBLEM — SP 14
Serial Problem — SP 14, Business Solutions (75 minutes)
Part 1
Total equity = $119,393
Part 2
Assume the secured loan is taken, then the percent of assets financed by:
a. Debt
($875 + $94,639) / ($120,268 + $94,639) = 44.4 %
b. Equity
Part 3
Santana Rey should understand the risks she is taking by borrowing funds
from the bank. She currently has no interest-bearing debt (per prior chapter
serial problems), but the loan will require her to pay interest. The interest
Reporting in Action — BTN 14-1
1. Apple reported long-term debt of $16,960 million as of September 28,
2013.
3. Assuming that Apple had $100 million carrying value of convertible
bonds that convert into 20,000 shares of stock, the following entry
would be recorded upon conversion:
4. Answer depends on the financial statement information obtained.
Comparative Analysis — BTN 14-2
1. Apple’s current year debt-to-equity ratio = $83,451 / $123,549 = 0.68
2. For both years, Apple’s debt-to-equity ratio is above that of the industry
average of 0.44. This implies that its debt levels are more risky than that
of its competitors. Conversely, for both years, Google’s debt-to-equity
Ethics Challenge — BTN 14-3
1. The ethics of the Traverse County officials are questionable. The
financial impact of the leasing arrangement is the same as bond
In reality, the taxpayers of Traverse County reacted very negatively to
the actions of the county officials when they learned of the leasing
arrangement. The taxpayers felt that their voice was taken out of the
2. Because the lease requires payments of a non-binding nature, investors
Communicating in Practice — BTN 14-4
MEMORANDUM
TO:
FROM:
SUBJECT:
The body of the memorandum should make the following points:
interest. This means that selling/buying at a premium incurs/yields an
effective rate of interest equivalent to the market rate for the risk assessed
for that bond at the time of issuance. In addition, this market rate of
interest is lower than the contract rate of interest for premium bonds.
A cordial closing that indicates willingness to discuss the issue further
would be appropriate.
Taking It to the Net — BTN 14-5
1. Home Depot’s long-term liabilities as of February 2, 2014, follow:
Long-term debt, excluding current installments............. $14,691
million
2 a. These Home Depot notes offer a 5.875% interest rate. If the interest
rate for similar notes from companies with similar risk was 5.875%,
b. Cash interest that must be paid:
$3,000,000,000 x 0.05875 x ½ year = $88,125,000
Teamwork in Action — BTN 14-6
Parts 1 and 2
Effective Interest Amortization of Bond Premium
Semi-
annual
Period-end
(A)
Cash
Interest
Paid
(B)
Bond
Interest
Expense
(C)
Premium
Amortization
(D)
Unamortized
Premium
(E)
Carrying
Value
1/01/2015 $ 4,100 $ 104,100
6/30/2015 $ 4,500 $ 4,164 $ 336 3,764 103,764
6/30/2017 4,500 4,107 393 2,281 102,281
Since teams generally have 4 or 5 members, the team solution will likely end about
here. The remainder of the table is shown for help in answering part 3.
12/31/2017 4,500 4,091 409 1,872 101,872
12/31/2019 4 ,500 3 ,955* 545 0 100,000
$45 ,000 $40 ,900 $4 ,100
*Discrepancy due to rounding.
The following computations should be articulated by team members as
each line is explained and prepared:
Column (A) Cash Interest Paid = Bonds' par value ($100,000) x Semiannual
contract rate (4.5%).
Column (B) Bond interest expense = Bonds’ prior period carrying value x
Semiannual market rate (4%).
Teamwork in Action (Concluded)
Part 3
Without completing the table, team members should be able to project the
final number in the first column and for each of the columns (A), (D), and
(E). Specifically:
(Col. 1) Last interest period date is 12/31/2019 because this is a five-year
bond, issued 1/1/2015, with semiannual interest payments made
on 6/30 and 12/31 of each year.
Part 4
Total Bond interest expense = Interest Paid - Premium
= ($4,500 x 10 periods) - $4,100
= $45,000 - $4,100 = $40,900
Part 5 List likely includes:
Similarities Differences
a. Table column headings
for the period and for
columns (A), (B), and (E).
a. Column (C) will be Discount Amortization and
Column (D) will be Unamortized Discount.
b. Dates in the period
column and interest paid in
column (A).
b. Bond interest expense is higher (lower) than the
interest paid and will increase (decrease) as we
amortize a discount (premium).
in both cases.
f. Unamortized discount
f. Computation of Column (E) will be previous Column
(E) plus discount amortization whereas with a
each period
Entrepreneurial Decision — BTN 14-7
Part 1
The table below reveals how the five alternative interest-bearing notes
would affect this company’s interest expense, net income, equity, and
return on equity (net income/equity):
Alternative Notes for Expansion
Current 10% Note 15% Note 16% Note 17% Note 20% Note
Income before
interest.............. $ 40,000 $ 56,000 $ 56,000 $ 56,000 $ 56,000 $ 56,000
Return on equity. . . 12% 14.4% 12.4% 12% 11.6% 10.4%
Part 2
The analysis in Part 1 illustrates the general rule (called “financial
leverage” or “trading on the equity”): When a company earns a higher
return with borrowed funds than it is paying in interest, it increases its
less than 16%.
The table in Part 1 reveals this result, where those notes with interest
expense below 16% are profitable (that is, yield a return greater than the
Hitting the Road — BTN 14-8
Global Decision — BTN 14-9
1. Samsung’s current year debt-to-equity ratio (in KRW millions):
Samsung’s prior year debt-to-equity ratio (in KRW millions):
2. Samsung’s debt-to-equity ratio decreased slightly from the prior year to
the current year. For the current year, Samsung’s debt-to-equity ratio is
