CASE 1.4 Chang Medical Electronics In 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 firm, 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 financial 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, La Salle Capital was unconcerned about the exact size of the debt issue. On May 1, 2008, five-year Treasuries yielded 3.1%, AAA-rated five-year corporate bonds yielded 5.57%, and Baa five-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 firm, depending on the terms. 1 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." Required 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. CHON ON OCTORY CAMS OM DOO PROPOSED BOND ISSUES, MAY 31, 2008 Deted yteld is the yield to maturity Cytm), assuming ytm equals the semi-annual discount rate x2 1A. 105 Coupon, 6-year bonds Principal acon): 3135.000.000 Coupon rate 18.50% kmount received present value): 5137271.338 Yield to maturity: 8.14% Semi-annual discount rate 4.07% Interest Change in Unamortized Net bond Payments expense bond premium premium payable 5 S 2,271.338 5 137,271,338 30-Nov 08 5.737,500 $ 5,586,943 5 (150,557) 5 2,120,782 S 137,120,782 31-May-09 5.737.500 $ 5,580,816 5 (156,684) $ 1.964,097 $ 136,964,097 5.737,500 5 5,574,439 5 (163,061) $ 1,801,036 136,801,036 28 31-May-10 5.737.500 $ 5,567,802 5 > (169,698) $ 1.631,338 136,631,338 30-Nov-10 5,737.500 55,560,895 (176,605) 5 1,454,734 136,454,734 31-May-11 5,737.500 55,553,708 (183,792) $ 1,270,941 136220 041 30-Nov1 5.737.500 5 5,546,227 5 (191.273) $ 1,079,669 136,079,669 5.737.500 $ 5,538,443 5 (199,057) $ 135,880,611 30-Nov-12 5.737.500 $ 5,530,341 $ (207,159) 5 673,452 135,673,452 31-May-13 5,737,500 $ 5,521,910 5 (215,590) S 135,457,862 30-Nov-13 5.737.500 5 5,513,135 5 (224,365) $ 233,497 $ 135,233.497 31-May-14 $ 140,737.500 $ 5,504,003 $ (233,497) 5 $ 135,000,000 30-Nov.09 31-May-12 880.611 457.862 10. 9 coupon, 6-year bonds Principal (face value of bonds): $140,000,000 Amount received (present value): 5138,499,036 8.00% 8.23% 4.12% Interest expense Change in bond discount Payments $ 31-May-08 30-Nov-08 31-May-09 30-Nov-09 5 5 $ 5,699,235 5.703,319 5,707,570 5,711,997 5,716,606 5.721,404 31-May-10 Coupon rate Yield to maturity Semi-annual discount rate Unamortized discount $ (1,500,964) $ (1,401,729) 5 5 (1,298,410) $ $ (1,190,840) S $ (1.078,843 5 $ (962,237) 5 5 (840,833) $ 5 (714,434) 5 5 (582,833) S 5 (445,816) $ $ (303,162) S $ (154,637) S 5 (0) $ 5.600.000 5,600.000 5.600.000 5,600,000 5.600 600.000 5.600.000 5.600.000 5.600.000 5.600.000 5.600.000 145.600.000 5.600.000 $ $ $ 5 5 s $ 3 $ 5 5 5 30-Nov-10 31-May-11 30-Nov-11 31-May-12 30-Nov-12 31-May-13 30-13 31-May-14 99,235 103,319 107.570 111.997 116.606 121,404 126,400 131.601 137,016 142,655 148,525 154,637 Net bond payable 138,499,036 138,598,271 138,701,590 138,809,160 138,921,157 139,037,763 139,159,167 139,285,566 139,417,167 139,554,184 139,696,838 139,845,363 140,000,000 5.726,400 5,731,601 5,737,016 5,742,655 5,748,525 5,754.637 5 5 5 (continued) CASE 1.4 CHANG MEDICAL ELECTRONICS 13 EXHIBIT 1-continued CHANG MEDICAL ELECTRONICS . 1C. Zero coupon, 6-year bonds Principal (face value of bonds): $225,000,000 Coupon rate : 0.00% Amount received (present value): $137,252,361 Yield to maturity: 8.41% Semi-annual discount rate 4.21% Interest Change in Unamortized Net bond Payments expense bond discount discount payable 31-May-08 $ (87.747,639) S 137,252,361 30-Nov-08 $ 5,771,462 $ 5,771,462 $ (81,976,178) S 31-May-09 143,023,822 $ 6,014,152 $ 6,014,152 $ (75,962,026) 5 149,037,974 30-Nov-09 $ 6,267,047 $ 6,267,047 $ (69,694,979) 5 155,305,021 31-May-10 6,530,576 $ 6,530,576 S (63,164,403) S 161,835,597 30-Nov-10 6,805,187 6,805,187 $ (56,359,216) 5 168,640,784 31-May-11 7,091,345 7,091,345 $ (49,267,871) S 175,732,129 30-Nov-11 7,389,536 S 7,389,536 S (41,878,335) 183,121,665 31-May-12 7.700,266 $ 7.700,266 $ (34,178,069) 30-Nov-12 8,024,062 $ 8,024,0625 (26,154,007) S 198,845,993 31-May-13 8,361,474 5 8,361,474 5 (17,792,533) S 207,207,467 30-Nov-13 8.713,074 $ 8,713,074 5 (9,079,459) $ 215,920,541 31-May-14 $ 225,000,000 $ 9,079,459 $ 9,079,459 $ (0) S 225,000,000 190,821,931