Investments. Clarence?s Chief Financial Officer loves to invest, so he uses Clarence?s money to invest in shares of other companies? stock. On 1/1/2007, Clarence purchased 1,000 shares of Llama Corporation. During fiscal 2008, Clarence purchased 1,000 shares of Goat Corporation. The Llama shares were purchased for $10.50 per share and the Goat shares were purchased for $7.20 per share. At the end of fiscal 2007, the fair market value of Llama was $10.90/share. At the end of fiscal 2008, the shares of Llama and Goat were worth $10.50 and $7.20 per share, respectively. Llama Corporation declared and paid cash dividends of $0.75 per share in both 2007 and 2008; Goat Corporation declared and paid a cash dividend of $0.50 per share in fiscal 2008. Clarence?s share of Llama?s stockholders? equity at the date of purchase was 10,000, with the entire difference between cost and book value attributable to equipment with a remaining useful life of five years (Llama uses straight-line for all depreciation and amortization). Llama?s total net income was $3,000 in 2007 and $3,500 in 2008. 6% Bonds. On July 1, 2007, Clarence issued 800 bonds. The bonds are 6% stated (face, coupon) rate, 10-year, non-convertible, callable bonds (each bond has a face value of $1,000 and they were issued at 107.7214). The bonds pay interest annually on July 1. The bond issue price was based on an effective interest rate of 5%. The bonds are callable anytime at 96 plus accrued interest. 5.5% Convertible bonds. In 2005, Clarence issued, at face value, $1,000,000 of 5.5%, 8-year, convertible, non-callable bonds (that is, it issued 1,000 bonds that each have a face value of $1,000). Each bond can be converted anytime by the bondholder into 24 shares of common stock. The bonds were issued on January 1, 2005 and pay interest annually on January 1. The effective interest method is used to amortize all bond discount or premium. Common Stock. On 1/1/08, there were 900,000 shares of $1 par value common stock authorized and 360,000 shares issued and outstanding. The 360,000 shares were originally issued on August 12, 2001 for $32 per share. Consequently, the balance in the paid-in capital from common stock account on 1/1/08 totals $11,160,000. The market price of Clarence?s stock typically fluctuates quite a bit. The next page contains detailed information about Clarence?s common stock price. 8% Convertible, cumulative, non-participating, Preferred Stock. There are 850 shares of $1,000 par, 8% preferred stock issued and outstanding. The preferred stock is cumulative and non-participating. Each share of preferred stock is convertible into four (4) shares of common stock. The preferred stock was issued at par in 1995. Preferred stock dividends were last declared and paid in fiscal 2006. Treasury Stock. Clarence purchased 40,000 shares of treasury stock on 4/1/08 for $32 per share and reissued 20,000 of these shares on 9/1/08 for $37 per share. Clarence uses the cost method to account for treasury stock transactions. 5. HW4 - 2 point If all of the convertible bonds were converted into common stock on January 1, 2009 when the fair market value of the stock was $55/share (after all entries to record interest expense were properly recorded), what would be the effect on net income? You must indicate increase, decrease, or no effect and, if increase or decrease, indicate a dollar amount.
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