The cloudy afternoon mirrored the mood of the conference of division managers

Ethics Case 14-8 Debt for equity swaps; have your cake and eat it too

The cloudy afternoon mirrored the mood of the conference of division managers. Claude Meyer, assistant to the controller for Hunt Manufacturing, wore one of the gloomy faces that were just emerging from the conference room. “Wow, I knew it was bad, but not that bad,” Claude thought to himself. “I don't look forward to sharing those numbers with shareholders.”

The numbers he discussed with himself were fourth quarter losses which more than offset the profits of the first three quarters. Everyone had known for some time that poor sales forecasts and production delays had wreaked havoc on the bottom line, but most were caught off guard by the severity of damage.

Later that night he sat alone in his office, scanning and rescanning the preliminary financial statements on his computer monitor. Suddenly his mood brightened. “This may work,” he said aloud, though no one could hear. Fifteen minutes later he congratulated himself, “Yes!”

The next day he eagerly explained his plan to Susan Barr, controller of Hunt for the last six years. The plan involved $300 million in convertible bonds issued three years earlier.

Meyer: By swapping stock for the bonds, we can eliminate a substantial liability from the balance sheet, wipe out most of our interest expense, and reduce our loss. In fact, the book value of the bonds is significantly more than the market value of the stock we'd issue. I think we can produce a profit.

Barr:  But Claude, our bondholders are not inclined to convert the bonds.

Meyer: Right. But, the bonds are callable. As of this year, we can call the bonds at a call premium of 1%. Given the choice of accepting that redemption price or converting to stock, they'll all convert. We won't have to pay a cent. And, since no cash will be paid, we won't pay taxes either.

Required:
Do you perceive an ethical dilemma? What would be the impact of following up on Claude's plan? Who would benefit? Who would be injured?

Click here for the solution: The cloudy afternoon mirrored the mood of the conference of division managers

On January 1, 2011, Adams-Meneke Corporation granted 25 million incentive stock options to division managers

E 19-6 Stock options; forfeiture of options

On January 1, 2011, Adams-Meneke Corporation granted 25 million incentive stock options to division managers, each permitting holders to purchase one share of the company's $1 par common shares within the next six years, but not before December 31, 2013 (the vesting date). The exercise price is the market price of the shares on the date of grant, currently $10 per share. The fair value of the options, estimated by an appropriate option pricing model, is $3 per option.

Required:
1. Determine the total compensation cost pertaining to the options on January 1, 2011.
2. Prepare the appropriate journal entry to record compensation expense on December 31, 2011.
3. Unexpected turnover during 2012 caused the forfeiture of 6% of the stock options. Determine the adjusted compensation cost, and prepare the appropriate journal entry(s) on December 31, 2012 and 2013.


Click here for the solution: On January 1, 2011, Adams-Meneke Corporation granted 25 million incentive stock options to division managers

Sapsora Company uses ROI to measure the performance of its operating divisions and to reward division managers

Sapsora Company uses ROI to measure the performance of its operating divisions and to reward division managers. A summary of the annual reports from two divisions is shown below. The company’s weighted-average cost of capital is 12 percent.

Division A Division B

Total Assets $6,000,000 $8,750,000

Current Liabilities 500,000 1,750,000

After-Tax Operating Income 1,000,000 1,180,000

ROI 25% 14%

a. Which division is more profitable?

b. Would EVA more clearly show the relative contribution of the two divisions to the company as a whole? Show the computations.

c. Suppose the manager of Division A was offered a one-year project that would increase his investment base by $250,000 and show a profit of $37,500. Would the manager choose to invest in the new project?

Click here for the solution: Sapsora Company uses ROI to measure the performance of its operating divisions and to reward division managers