T.C.O. D. Hurst Inc. Sold Its 8 Bonds With Maturity Value
3tco D Hurst Incorporated Sold Its 8 Bonds With A Maturity Value
Hurst, Incorporated sold its 8% bonds with a maturity value of $3,000,000 on August 1, 2009, for $2,946,000. At that time, the bonds had five years remaining until maturity, with interest payable semiannually on August 1 and February 1. The bonds are callable at 104 at any time after August 1, 2011. By October 1, 2011, the market interest rate declined, and the bond price rose to 101. The firm decided to refund these bonds by issuing new 6% bonds maturing in five years. Hurst started reacquiring its 8% bonds in the market, purchasing $500,000 worth at 101, and the remaining bonds were called at 104. The goal is to determine the total gain or loss Hurst experienced from reacquiring its bonds, assuming straight-line amortization.
Paper For Above instruction
The analysis of Hurst, Incorporated’s reacquisition of its bonds involves understanding the bond’s original sale, amortization, and the gains or losses resulting from market reacquisition and call features. The main task is to quantify the overall gain or loss Hurst experienced in reacquiring its bonds, considering market conditions, bond pricing, and the amortization process.
1. Background and Initial Bond Issuance
Hurst issued bonds with an face value of $3,000,000 at an coupon rate of 8%, selling for $2,946,000. The bonds had five years remaining and paid interest semiannually, resulting in 10 interest periods. The bonds' issue price was below par, indicating a discount due to the market rate possibly being higher than the coupon rate at the time of issuance.
2. Amortization of the Discount
Given the straight-line amortization method, the total discount on issuance was $3,000,000 - $2,946,000 = $54,000. This discount amortized evenly over 10 periods (since interest is semiannual), resulting in an amortization of $5,400 per period.
3. Bond Market Conditions and Reacquisition
By October 1, 2011, the bond price increased to 101, or 101% of face value, reflecting the decline in market interest rates. This translates to a market price of $3,030,000 ($3,000,000 × 1.01). Hurst purchased bonds worth $500,000 at a price of 101, i.e., $505,000 ($500,000 × 1.01).
4. Call of Remaining Bonds
The remaining bonds were called at 104, which is 104% of face value, or $3,120,000 ($3,000,000 × 1.04). The average cost of reacquiring bonds includes the purchase at 101 and the call at 104. Since Hurst was able to purchase some bonds at 101, and the rest was called at 104, the total reacquisition costs must be considered together.
5. Calculation of Total Reacquisition Cost
Reacquired bonds at 101 cost: $505,000 for $500,000 of bonds.
Remaining bonds purchased or called at 104: $2,495,000 for bonds at cost of $2,545,000 (since at 104, bonds cost $3,120,000, and this is the total face value minus the portion purchased at 101).
The total reacquisition cost is therefore a weighted sum of these prices, but for simplicity, we look at total bonds and their respective prices.
6. Gain or Loss Calculation
To determine the overall gain or loss, we compare the reacquisition costs to the carrying amount of the bonds, considering amortization and accounting for discounts and premiums. The bonds' carrying amount at the time of reacquisition reflects the original bond issue amount plus amortized discount.
Original carrying value: $2,946,000 plus accumulated amortization over 4.75 years (since approximately 9.5 periods) should be considered, but for simplicity, we will assume straight-line amortization has evenly reduced the discount to reflect the bonds' book value at this date.
Remaining discount: $54,000 - ($5,400 × 9) = $0, indicating complete amortization at this point (since the last interest payments are near). Thus, the bond's book value is close to face value of $3,000,000.
7. Final Calculation of Gain/Loss
The actual reacquisition involves purchasing bonds in the market at a premium and calling the rest at a premium. The difference between the reacquisition costs and the book value of bonds indicates a net gain or loss.
Summarizing, Hurst’s total bond reacquisition cost includes:
- $505,000 for bonds purchased at 101
- $3,120,000 for bonds called at 104
The total cost is $3,625,000.
The book value of bonds, considering approximate straight-line amortization, is nearly $3,000,000. Therefore, the net loss is approximately $3,625,000 - $3,000,000 = $625,000.
This indicates Hurst experienced an overall loss of about $625,000 upon reacquiring its bonds, factoring in the premiums paid at market purchase and call prices, offset somewhat by amortization of bond discounts and premiums. Precise calculations would involve detailed amortization entries, but this analysis provides an estimate based on the information given, highlighting how market movements and refinancing strategies impact the financial outcomes for bond issuers.
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