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, LaSalle 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. "I put together three proposals (Exhibit 1)," Ms. Hupp said. "(IA) is a six-year 8.5% bond; (IB) is a six-year 8% bond; (IC) 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. 12 30-Nov-08 31-May-09 30-Nov-09 1A. 10% Coupon, 6-year bonds Principal (Tace value of bonds): $135,000,000 Amount received (present value): $137.271.338 31-May-10 30-Nov-10 31-May-11 30-Nov-11 31-May-12 30-Nov-12 31-May-08 30-Nov-08 SECTION ONE INTRODUCTORY CASES 31-May-09 30-Nov-09 31-May-10 10 30-Nov-10 31-May-11 30-Nov-11 31-May-12 30-Nov-12 S 5,737,500 31-May-13 5,737,500 30-Nov-13 5,737,500 31-May-14 $ 140,737.500 31-May-13 30-Nov-13 31-May-14 PROPOSED BOND ISSUES, MAY 31, 2008 Quoted yield is the yield to maturity (ytm), assuming ytm equals the semi-annual discount rate x2 Payments 18. 9% coupon, 6-year bonds Principal (face value of bonds): $140,000,000 Amount received (present value): $138,499,036 S Interest expense 5.737,500 5.737.500 5,737,500 $ 5.737.500 $ 5,737,500 $ $ 5,737,500 5.737.500 $ 5.737,500 $ $ $ 5,521,910 S $ 5,513,135 Payments Change in bond premium $ 145,600,000 Interest expense $ $ 2,271.338 $ 137,271.338 $ 5,586,943 $ (150,557) 2,120,782 $ 137,120,782 $ 5,580,816 $ (156,684) $ 1,964,097 $ 136,964,097 5,574,439 $ (163,061) 5,567,802 $ (169,698) (176,605) (183,792) 3 1,801,036 $ 1.631,338 5,560,895 $ 5,553,708 $ 3 S 3 5,546,227 $ (191,273) $ 5,538,443 S (199,057) $ 5,530,341 S (207,159) $ (215,590) $ S (224,365) S $ 5.504,003 $ (233,497) S Change in bond discount $5,726,400 S $ 5,731,601 S 5,600,000 $ 5,737,016 S S 5.600.000 $ 5,742.655 5,600,000 $ 5,748,525 $ S S 5,754.637 Coupon rate 18.50% Yield to maturity: 8.14% Semi-annual discount rate Unamortized premium S : S $ 136,801,036 $ 136,631,338 $ 136,454,734 1,454,734 1,270,941 $ 136,270,941 4 610220 1.079.669 $ 136,079,669 135,880,611 S 880,611 673,452 $ 135,673,452 S 457.862 233,497 $ 135,457,862 135,233,497 135,000,000 0 $ Coupon rate Yield to maturity: Semi-annual discount rate Unamortized discount 4.07% Net bond payable : : 8.00% 8.23% S 5,600,000 $ S 5,600,000 S 5.600,000 S 5,600,000 S $ (1,078,843) $ $ (962,237) $ S (1,500,964) 5,699,235 $ 99,235 S (1,401,729) 5.703,319 $ 103,319 S (1,298,410) $ 138,701,590 5,707,570 $ 107.570 $ (1,190,840) S 138,809,160 111.997 5,711.997 $ 138,921,157 * 5,600,000 S 5.716.606 S 116,606 139,037,763 ? 5,600,000 S 5.721.404 121,404 $ (840,833) $ 139,159,167 126,400 S (714,434) $ 139,285,566 131,601 $ (582,833) $ 139,417,167 137,016 S (445,816) $ 139,554,184 142,655 S (303,162) $ 139,696,838 148,525 S (154,637) $ 139,845,363 154,637 S (0) $ 140,000,000 5,600,000 5,600,000 (continued) 4.12% Net bond payable 138,499,036 138,598,271 CASE 1.4 CHANG MEDICAL ELECTRONICS EXHIBIT 1-continued CHANG MEDICAL ELECTRONICS 1C. Zero coupon, 6-year bonds Principal (face value of bonds): $225,000,000 Amount received (present value): $137,252,361 31-May-08 $ 30-Nov-08 31-May-09 30-Nov-09 31-May-10 34 10 30-Nov-10 21 Mar 31-May-11 30-Nov-11 30-Nov-11 Payments - $ $ $ $ $ $ S 31-May-12 30-Nov-12 31-May-13 30-Nov-13 S 31-May-14 $ 225,000,000 $ S $ $ Interest expense Change in bond discount 5,771,462 $ 6,014,152 $ 6,267,047 S 6,530,576 $ 6,805,187 S 7,091,345 S Tu 7,389,536 $ 7,700,266 $ Coupon rate : Yield to maturity: Semi-annual discount rate : (87,747,639) S $ 5,771,462 $ (81,976,178) S 6,014,152 $ (75,962,026) S 6,267,047 $ (69,694,979) S 6,805,187 $ 7,091,345 $ Unamortized discount 6,530,576 $ (63,164,403) S (56,359,216) $ (49,267,871) S (41,878,335) S (34,178,069) S (26,154,007) S 7,389,536 $ 7,700,266 $ 8,024,062 $ 8,024,062 $ 8,361,474 S 8,361,474 S 8,713,074 $ 8,713,074 S 9,079,459 $ 9,079,459 $ 0.00% 8.41% (17,792,533) S (9,079,459) S 4.21% Net bond payable 137,252,361 143,023,822 149,037,974 155,305,021 161,835,597 168,640,784 175,732,129 183.121.665 190,821,931 198,845,993 207,207,467 215.920.541 (0) $ 225,000,000 13