Question

Required: What amount should Jennifer report in its 2017 income statement as loss on extinguishment of debt (ignore taxes)? 5. On January 1, 2016, Aaron Hotchner loaned $5,795,518 to Stephen Walker Company. A zero-interest-bearing note (face amount, $18 million) was exchanged solely for cash. The note is to be repaid on December 31, 2025. a. What is the effective interest rate on this note? b. Assuming a December 31, 2016 year-end, what is the amount of interest expense to be shown on the income statement of Stephen Walker Company? c. Show how this note would be reported on Stephen Walker Company's December 31, 2016 Balance Sheet.

Answer 1

a) The amount paid for note (i.e. 5,795,518) is equal to present value of face value (i.e. $18 million) of note discounted at effective interest rate over the life of note.

Present Value of Note = Face value of note*PVF(i%, 10 yrs) (10 years, 2016 to 2025)

(where i% is effective interest rate)

5,795,518 = 18,000,000*PVF(i%, 10 yrs)

PVF(i%, 10 yrs) = 5,795,518/18,000,000 = 0.32197

From the present value factor table the value 0.32197 for 10 years is at 12%.

Therefore the effective interest rate on this note is 12%.

b) Interest Expense on Note for Dec 31, 2016 = Notes payable balance outstanding*12%

= $5,795,518*12% = $695,462

Therefore interest expense to be shown on the income statement of Stephen Walker Company is $695,462.

c) Notes Payable balance on Dec 31, 2016 = $5,795,518+$695,462

= $6,490,980

Partial balance sheet as on Dec 31, 2016 is shown as follows:-

Stephen Walker Company
Partial Balance Sheet
As on Dec 31, 2016 (Amounts in $)
Long Term Liabilities
Notes Payable, Long-Term	6,490,980