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Delray Technology

Problem 1

Delray Technology is considering these two alternatives to finance its construction of a new $2 million plant:

(a) Issuance of 200,000 shares of common stock at the market price of $10 per share.
(b) Issuance of $2 million, 6% bonds at face value.

Complete the table and indicate which alternative is preferable.

Issue Stock Issue Bond
Income before interest and taxes $1,000,000 $1,000,000
Interest expense from bonds
Income before income taxes
Income tax expense (30%)
Net income
Outstanding shares 700,000
Earnings per share $ $

Problem 2

Assume that the following are independent situations recently reported in a newspaper.

1. Delray Technology 7% bonds, maturing January 28, 2010, were issued at 111.12.
2. Synergy Financial Corp 7% bonds, maturing September 24, 2027, were issued at 99.08.

Instructions
(a) Were Company A and B bonds issued at a premium or a discount?
(b) Explain how bonds, both paying the same contractual interest rate, could be issued at different prices.
(c) Prepare the journal entry to record the issue of each of these two bonds, assuming each company issued $500,000 of bonds in total.

Problem 3

On October 1, 2006, Delray Technology issued $500,000, 7%, 10-year bonds at face value. The bonds were dated October 1, 2006 and pay interest annually on October 1. Financial statements are prepared annually on December 31.

Instructions
(a) Prepare the journal entry to record the issuance of the bonds.
(b) Prepare the adjusting entry to record the accrual of interest on December 31, 2006.
(c) Show the balance sheet presentation of bonds payable and bond interest payable on
December 31, 2006.
(d) Prepare the journal entry to record the payment of interest on October 1, 2007.
(e) Prepare the adjusting entry to record the accrual of interest on December 31, 2007.
(f) Assume that on January 1, 2008, Delray Technology pays the accrued bond interest and calls the bonds. The call price is 102. Record the payment of interest and redemption of the bonds.

Problem 4

Delray Technology has 7,000 shares of common stock outstanding. It declares a $1 per share cash dividend on November 1 to stockholders of record on December 1. The dividend is paid on December 31. Prepare the entries on the appropriate dates to record the declaration and payment of the cash dividend.

Problem 5

The stockholders' equity section of Delray Technology's balance sheet consists of common stock ($10 par) $1,000,000 and retained earnings $400,000. A 10% stock dividend (10,000 shares) is declared when the market value per share is $19. Show the before and after effects of the dividend on (a) the components of stockholders' equity and (b) the shares outstanding.

Problem 6

Delray Technology sold $4,000,000, 8%, 20-year bonds on January 1, 2007.
The bonds were dated January 1, 2007 and pay interest on December 31. The bonds were sold at 98.

Instructions
(a) Prepare the journal entry to record the issuance of the bonds on January 1, 2007.
(b) At December 31, 2007, $4,000 of the bond discount had been amortized. Show the balance sheet presentation of the bond liability at December 31, 2007. (Assume that interest has been paid.)

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Problem 1

Delray Technology is considering these two alternatives to finance its construction of a new $2 million plant:

(a) Issuance of 200,000 shares of common stock at the market price of $10 per share.

(b) Issuance of $2 million, 6% bonds at face value.

Interest expense from bonds = $2,000,000 x 6% = $120,000

Complete the table and indicate which alternative is preferable.

Issue Stock Issue Bond
Income before interest and taxes $1,000,000 $1,000,000
Interest expense from bonds 0 $ 120,000
Income before income taxes $1,000,000 $ 880,000
Income tax expense (30%) $ 300,000 $ 264,000
Net income $ 700,000 $ 616,000
Outstanding shares 2,700,000 700,000
Earnings per share $ 0.26 $ 0.88

We would prefer the issuance of $2 million, 6% bonds because earnings per share under this alternative is higher.

Problem 2

Assume that the following are independent situations recently reported in a newspaper.

1. Delray Technology 7% bonds, maturing January 28, 2010, were issued at 111.12.
2. Synergy Financial Corp 7% bonds, maturing September 24, 2027, were issued at 99.08.

Instructions
(a) Were Company A and B bonds issued at a premium or a discount?

Delray Technology issued the bonds at a premium because its price is higher than the face value while Synergy Financial Corp. issued the bonds at a discount because its price is lower than the face value.

(b) Explain how bonds, both paying the same contractual interest rate, could be issued at different prices.

The bond with the longer time to maturity will have ...

Solution Summary

This solution is comprised of a detailed explanation to explain how bonds, both paying the same contractual interest rate, could be issued at different prices and prepare the journal entry to record the issue of each of these two bonds, assuming each company issued $500,000 of bonds in total.

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