11CASE 1.4Chang Medical ElectronicsIn 1972, Dr. Ahn Chang, an MIT physics professor, moved to Portland, Oregon, to provide consulting services to West Coast electronics firms. Within three years, Dr. Chang developed a proprietary health-care product, and his consulting firm evolved into Chang Medical Electronics (CME). Neither his son nor daughter was interested in working at the fi rm, so in mid-2008 Dr. Chang agreed to sell CME to LaSalle Capital, a private equity group.LaSalle Capital proposed to acquire CME by paying CME $10 million for 1,000,000 newly issued common shares at $10 per share and $50 million for mandatorily redeemable preferred stock that paid a 10% cumulative annual dividend. CME would then sell about $140 million of bonds to fi nancial institutions through Rainier International, a West Coast investment bank. The $60 million investment from LaSalle Capital, plus the $140 million from newly issued debt, would be used to buy Dr. Chang's 1,825,000 shares of common stock for $102 per share ($186,150,000). Because CME would have adequate cash after the transaction closed, LaSalle Capital was unconcerned about the exact size of the debt issue.On May 1, 2008, fi ve-year Treasuries yielded 3.1%, AAA-rated fi ve-year corporate bonds yielded 5.57%, and Baa fi ve-year corporate bonds yielded 6.93%. John Tilden, the LaSalle partner managing the CME acquisition, hoped to pay no more than 7.5%. Susan Hupp, the Rainier International banker managing the deal, believed the market yield to maturity would be between 8.15% and 8.5% for a small issue from a highly leveraged fi rm, depending on the terms."I put together three proposals (Exhibit 1)," Ms. Hupp said. "(1A) is a six-year 8.5% bond; (1B) is a six-year 8% bond; (1C) is a six-year zero-coupon bond. Your yield to maturity should be about 8.14% with the 8.5% bond, 8.23% with the 8% bond, and 8.41% with the zero-coupon bond. I rounded each issue to the nearest $5 million so the amounts you receive under each issue differ slightly.

1. For each proposed issue, prepare journal entries to record the initial bond sale and the November 30, 2008, interest payment.

2. Explain why the net bond payable changes with each interest payment. For example, explain why the net bond payable for the zero-coupon bond increases from $137,252,361 to $143,023,822 between May 31, 2008, and November 30, 2008.

3. Why are there different interest rates on the different bonds, even though they mature on the same date? Explain in detail.

4. If LaSalle needed to raise about $200 million, approximately how many $1,000 zero-coupon bonds would it issue?

5. Suppose CME issued $140 million of 8% coupon bonds on May 31, 2008, for $138,499,036, as in Exhibit 1(B). Also suppose that on May 31, 2010, immediately after it paid the $5.6 million interest payment, CME reacquired the entire bond issue for $141,275,000. Show the required journal entry. Show the journal entry if CME instead re-acquired the entire bond issue for $137,250,000.