On January 1, 2008, Colt Corporation issued $3,000,000 of 5-year, 8% bonds at 97. The bonds pay interest annually on January 1. By January 1, 2010, the market rate of interest for bonds of risk similar to those of Colt Corporation had risen. As a result the market value of these bonds was $2,500,000 on January 1, 2010—below their carrying value of $2,946,000.

Rich Heyman, president of the company, suggests repurchasing all of these bonds in the open market at the $2,500,000 price. But to do so the company will have to issue $2,500,000 (face value) of new 10-year, 12% bonds at par. The president asks you, as controller, “What is the feasibility of my proposed repurchase plan?”

Instructions

With the class divided into groups, answer the following.

(a) Prepare the journal entry to retire the 5-year bonds on January 1, 2010. Prepare the journal entry to issue the new 10-year bonds.

(b) Prepare a short memo to the president in response to his request for advice. List the economic factors that you believe should be considered for his repurchase proposal.