Question

A town plans to borrow about $10 million and is considering three alternatives. At own official requests your guidance on the economic cost of each of the arrangements and advice as to how they would affect the towns reported expenditures.
1. For each of the town’s three alternatives, determine
(1) What the town’s economic cost would be of using the funds in the year ending December 31, 2015, and
(2) What amount of interest expenditure the town would be required to report for the year ending December 31, 2015 in its governmental funds.
a. The town would issue $10 million of 20-year, 6 percent coupon bonds on July 1, 2015. The bonds would be issued at par. The town would be required to make its first interest payment of $300,000 on January 1, 2016.
b. The town would issue $10 million of 20-year, 6 percent bonds on June 30, 2015. The bonds would be sold for $9,552,293, a price that reflects an annual yield (effective interest rate) of 6.4 percent. The town would be required to make its first interest payment of $300,000 on December 31, 2015.
c. The town would issue $32,071,355 of 20-year zero coupon bonds on July 1, 2015. The bonds would be sold for $10 million, an amount that reflects an annual yield of 6 percent. The bonds require no payment of principal or interest until June 30, 2035.
2. Suppose that the town elects the first option and issues $10 million of 20-year, 6 percent coupon bonds at par on July 1, 2015. The town establishes a debt service fund to account for resources that it sets a side to pay principal and interest on the bonds. On December 31, 2015, the town transfers $300,000 from the general fund to the debt service fund to cover the first interest payment that is due on January 1, 2016.
a. How would the transfer be reported in the general fund?
b. How would the transfer be reported in the debt service fund? What options are available to the town to record 2015 interest in the debt service fund?
3. Suppose that the town borrowed $10 million on July 1, 2015, and temporarily invested the proceeds in two-year, 6 percent Treasury notes. The first payment of interest, $300,000, is payable on January 1, 2016.
a. What would be the town’s economic gain from investing the funds in the year ending December 31, 2015? Ignore borrowing costs.
b. How much investment revenue should the town report for the year ending December 31, 2015? Assume there was no change in prevailing interest rates.



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  • CreatedAugust 13, 2014
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