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 Capita was unconcerned about the exact size of the debt issue. On May 1, 2008, five-year Treasuries yielded 3.1%, AAA-rated five-year corporat bonds yielded 5.57%, and Baa five-year corporate bonds yielded 6.93%. John Tilder the LaSalle partner managing the CME acquisition, hoped to pay no more than 7.59 Susan Hupp, the Rainier International banker managing the deal, believed the mark yield to maturity would be between 8.15% and 8.5% for a small issue from a high leveraged firm, 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 maturity should be about 8.14% with the 8.5% bond, 8.23% with the 8% bond, a 8.41% with the zero-coupon bond. I rounded each issue to the nearest $5 million the amounts you receive under each issue differ slightly." CASE 1.4 CHANG MEDICAL ELECTRONICS EXHIBIT 1-continued CHANG MEDICAL ELECTRONICS 10. Zero coupon, 6-year bonds Principal (face value of bonds): $225,000,000 Amount received (present value): $137,252,361 0.00% 8.41% Coupon rate : Yield to maturity: Semi-annual discount rate : 4.21% Interest expense Payments $ 31-May-08 30-Nov-08 31-May-09 30-Nov-09 31-May-10 30-Nov-10 31-May-11 30-Nov-11 31-May-12 30-Nov-12 31-May-13 30-Nov-13 31-May-14 $ $ $ $ $ $ $ $ $ $ $ $ 5,771,462 6,014,152 6,267,047 6,530,576 6,805,187 7,091,345 7,389,536 7,700,266 8,024,062 8,361,474 8,713,074 9,079,459 Change in Unamortized bond discount discount $ (87,747,639) $ $ 5,771,462 $ (81,976,178) $ $ 6,014,152 $ (75,962,026) $ $ 6,267,047 $ (69,694,979) $ $ 6,530,576 $ (63,164,403) $ $ 6,805,187 $ (56,359,216) $ $ 7,091,345 $ (49,267,871) $ $ 7,389,536 $ (41,878,335) $ $ 7,700,266 $ (34,178,069) $ $ 8,024,062 (26,154,007) $ 8,361,474 $ (17,792,533) $ 8,713,074 $ (9,079,459) $ $ 9,079,459 $ (0) $ Net bond payable 137,252,361 143,023,822 149,037,974 155,305,021 161,835,597 168,640,784 175,732,129 183,121,665 190,821,931 198,845,993 207,207,467 215,920.541 225,000,000 A tA A A A A $ 225,000,000 PROPOSED BOND ISSUES, MAY 31, 2008 Quoted yield is the yield to maturity (ytm), assuming ytm equals the semi-annual discount rate x 2 1A. 10% Coupon, 6-year bonds Principal (face value of bonds): $135,000,000 Coupon rate Amount received (present value): $137,271,338 Yield to maturity: Semi-annual discount rate : 8.50% 8.14% : 4.07% Change in Payments Interest expense bond premium $ $ $ $ $ $ AAAA $ $ $ $ $ 31-May-08 30-Nov-08 31-May-09 30-Nov-09 31-May-10 30-Nov-10 31-May-11 30-Nov-11 31-May-12 30-Nov-12 31-May-13 30-Nov-13 31-May-14 5,737,500 5,737,500 5,737,500 5,737,500 5,737,500 5,737,500 5,737,500 5,737,500 5,737,500 5,737,500 5,737,500 140,737,500 A LA 5,586,943 5,580,816 5,574,439 5,567,802 5,560,895 5,553,708 5,546,227 5,538,443 5,530,341 5,521,910 5,513,135 5,504,003 Unamortized premium $ 2,271,338 $ 2,120,782 $ 1,964,097 1,801,036 $ 1,631,338 $ 1,454,734 $ 1,270,941 $ 1,079,669 $ 880,611 $ 673,452 $ 457,862 $ 233,497 $ 0 $ $ $ $ $ $ $ $ $ $ $ $ AAAA (150,557) (156,684) (163,061) (169,698) (176,605) (183,792) (191,273) (199,057) (207,159) (215,590) (224,365) (233,497) Net bond payable 137,271,338 137,120,782 136,964,097 136,801,036 136,631,338 136,454,734 136,270,941 136,079,669 135,880,611 135,673,452 135,457,862 135,233,497 135,000,000 A A A A A A $ $ $ $ $ $ 13. 9% coupon, 6-year bonds Principal (face value of bonds): $140,000,000 Amount received (present value): $138,499,036 Coupon rate : Yield to maturity: Semi-annual discount rate : 8.00% 8.23% 4.12% Interest expense Payments Change in bond discount $ $ $ $ $ $ $ $ $ $ 31-May-08 30-Nov-08 31-May-09 30-Nov-09 31-May-10 30-Nov-10 31-May-11 30-Nov-11 31-May-12 30-Nov-12 31-May-13 30-Nov-13 31-May-14 5,600,000 5,600,000 5,600,000 5,600,000 5,600,000 5,600,000 5,600,000 5,600,000 5,600,000 5,600,000 5,600,000 145,600,000 5,699,235 5,703,319 5,707,570 5,711,997 5,716,606 5,721,404 5,726,400 5,731,601 5,737,016 5,742,655 5,748,525 5,754,637 $ $ $ $ $ $ $ Unamortized discount $ (1,500,964) $ (1,401,729) $ (1,298,410) $ (1,190,840) $ (1,078,843) (962,237) (840,833) (714,434) $ (582,833) (445,816) $ (303,162) $ (154,637) (0) 99,235 103,319 107,570 111,997 116,606 121,404 126,400 131,601 137,016 142,655 148,525 154,637 AAAA 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 ta ta ta ta ta ta $ $ AtA A A A A A A ta ta ta ta ta A A A A $ (continued) 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