Question
On January 1, 2016, Labtech Circuits borrowed $120,000 from First Bank by issuing a two-year, 9% note, payable on December 31, 2018. Labtech wanted to
| On January 1, 2016, Labtech Circuits borrowed $120,000 from First Bank by issuing a two-year, 9% note, payable on December 31, 2018. Labtech wanted to hedge the risk that general interest rates will decline, causing the fair value of its debt to increase. Therefore, Labtech entered into a two-year interest rate swap agreement on January 1, 2016, and designated the swap as a fair value hedge. The agreement called for the company to receive payment based on an 9% fixed interest rate on a notional amount of $120,000 and to pay interest based on a floating interest rate tied to LIBOR. The contract called for cash settlement of the net interest amount on December 31 of each year. |
| Floating (LIBOR) settlement rates were 9% at inception and 10%, 8%, and 8% at the end of 2016, 2017, and 2018, respectively. The fair values of the swap are quotes obtained from a derivatives dealer. These quotes and the fair values of the note are as follows: |
| January 1 | December 31 | |||||||||||
| 2016 | 2016 | 2017 | 2018 | |||||||||
| Fair value of interest rate swap | 0 | $ | (1,959 | ) | $ | 1,135 | $ | 0 | ||||
| Fair value of note payable | $ | 120,000 | $ | 118,041 | $ | 121,135 | $ | 120,000 |
| Required: | |
| 1. | Calculate the net cash settlement at the end of 2016, 2017, and 2018.(Negative amounts should be indicated by a minus sign.) |
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Income Tax Fundamentals 2013
Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill
31st Edition
1111972516, 978-1285586618, 1285586611, 978-1285613109, 978-1111972516
