I) J. J. Walter is the Chief Executive Officer of JJW Industries. He and other executives are contemplating whether or not to issue long- term debt to finance plant expansion and renovation. In the past, his company has issued traditional debt instruments that require regular interest payments and a retirement of the principal on the maturity date. However, he has noticed that several competitors have recently issued bonds that either do not require interest payments or defer interest payments for several years. He has asked you, the companys controller, to prepare a two-page memo addressing the following questions.
1. Why would a company issue bonds that require interest payments if bonds that do not require interest payments are being sold in the open market?
2. If the company were to issue 10-year bonds with a face value of $ 100,000 and the market raste of interest is 10%, what would be the proceeds from the sale if the bonds were zero- interest bonds? What would be the proceeds if the annual interest payments did not begin for five years and the stated rate of interest were 10%? What would be the proceeds if the bonds paid interest annually for 10 years at 10%?
3. What factors must a business consider when determining the interest terms associated with long- term debt?
II) Damijo Company has been very successful in recent years. Cash flow from operations is more than sufficient to cover the cost of all capital expenditures as well as regular cash dividends. To utilize some of the extra cash, Damijo decided to begin a program of repurchasing its shares in the open market. The shares will not be retired but will be held for potential reissue. Because Damijo has never repurchased its shares before, it has not had to make a choice between the par value and cost methods of accounting for treasury stock.
As the chief accounting officer in the company, you have been asked to draft a memo to the board of directors recommending either the cost method or the par value method of accounting for treasury stock. Your memo should address issues such as the prevailing practice, the likely effect on the financial statements (particularly the Equity section), and the potential impact of the treasury stock accounting treatment on the ability to maintain steady cash dividend payments in the future.