Century and beyond bonds $($LO $12-1,$ LO $12-2)$

As a senior partner at one of the nation$$s largest public accounting firms, you serve as chair of the firm$$s financial reporting policy committee. You are also the firm$$s chief spokesperson on financial reporting matters that come before the FASB and the Securities and Exchange Commission. The year is $20$X$1.$

Two new debt securities have caught the attention of your committee, the FASB, the SEC, Congress, and the Treasury Department. Draper, Inc., recently completed a $$200$ million offering of so$-$called century bonds that mature in $21$X$1,$ or in $100$ years. Castle Company announced that it will issue $$250$ million of millennium bonds that mature in $30$X$1,$ or in $1,000$ years. Neither company is a client of your firm. The Treasury Department and Congress have proposed limiting interest deductions for long$-$term bonds to $40$ years. They argue that $100-$year debt should be treated the same as equity because the bonds are more like permanent capital. Their reasoning is that given that stock dividend payments cannot be deducted from taxable income, interest payments on the last $60$ years of $100-$year debt should not be deducted.

Required:

Suppose that Draper, Inc., issued its $$200$ million century bonds on January $1,20$X$1,$ at a market yield of $7\mathrm{.}5\%,$ the same as the stated interest rate. To keep things easy, also assume that the bonds pay interest just once a year, on December $31.$ Compute the bonds$$ issue price. How much of that price comes from the present value of the interest payments, and how much comes from the promised principal payment?

In present value terms, how much of a tax savings does the company obtain from its century bond? $($Use a $21\%$ effective tax rate.$)$ How much of a tax savings would be lost if only the first $40$ years of interest deductions were allowed?

Suppose that the Draper century bonds were issued with a stated rate of $7\mathrm{.}5\%$ when the market yield rate was $8\mathrm{.}5\%.$ What would the issue price be$?$ How about if the market yield were $6\mathrm{.}5\%?$

In October $2011,$ The Ohio State University sold $$500$ million worth of $100-$year bonds, becoming the first public university to issue a so$-$called century bond. The bonds were priced to yield $4\mathrm{.}849\%,$ which was $1\mathrm{.}70$ percentage points over $30-$year Treasury rates. Ohio State was established in $1870,$ has $64,077$ enrolled students, and has a campus of more than $1,700$ acres with $457$ buildings. Two private universities, Massachusetts Institute of Technology $($MIT$)$ and the University of Southern California, had issued century bonds earlier that year. Typically, universities such as Ohio State issue $30-$year tax$-$free bonds with fixed or floating interest rates. Public and private universities are tax$-$exempt institutions, but the income from century bonds is taxable to the buyer. What are the likely economic advantages to Ohio State of issuing century bonds?

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Why would the Treasury Department and members of Congress be opposed to unlimited interest deductions on century and millennium bonds?

According to U$.$S$.$ GAAP, are these securities debt or equity?