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Susan's Tire Tower Case Study

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Susan’s Tire Tower wants to switch to effective interest amortization method from straight-line method. Therefore, Susan has asked me to write this memo to you to clarify the different between these two methods of amortization. How to determine the selling price of the bond? The selling price of the discounted bond is the sum of the present value of cash interest (face value X stated rate) and present value of the bond’s face value. In Susan’s Tire Tower’s case, the bond is expected to be a 4-year, $1,000,000 face value, 4% bond with an effective annual yield of 6%. This bond is selling as discounted bond because the stated rate (4%) is less than the market rate (6%). Interest will be payable semiannually, so the stated rate and market rate …show more content…

Therefore, we need to eliminate that remaining premium or discount before redeeming the bond. To know if redeeming bond before maturity is good or bad for a company, we need to consider two values, the cash that the company spend to early redeem the bond and the carrying value of a bond at the point of redeeming. If the cash paid is greater than the carrying value, the company records a gain in retirement of bonds. If cash paid is lesser than the carrying value, the company records a loss in retirement of bonds. Is redeeming bond before maturity good for Susan’s Tire Tower? In Susan’s Tire Tower case, the company would like the bonds to be callable at 101 at any time on or after March 1, 2021. If the company would like to early redeem the bond anytime after March 1, 2021 and before the maturity date March 1, 2023, the cash paid to early redeem the bond (101% x 1,000,000 = $1,010,000) is greater than the carrying value of the bond at the time of redemption (carrying value falls between $962,828 and $1,000,000). Therefore, Susan’s Tire Tower is going to record a loss if the company would like the bonds to be callable at 101 at any time on or after March 1,

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