Question

On May 1, 2010, Marly Co. issued $500,000 of 7% bonds at 103, which are due on April 30, 2020. Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Marly's common stock, $15 par value, were attached to each $1,000 bond. The bonds without the warrants would sell at 96. On May 1, 2010, the fair value of Marly's common stock was $35 per share and of the warrants was $2.

On May 1, 2010, Marly should record the bonds with a
a. discount of $20,000.
b. discount of $5,000.
c. discount of $5,600.
d. premium of $15,000.

Answer 1

On May 1, 2010, Marly Co. should record the bonds with a discount of $5,600.

Step-by-step explanation:

On May 1, 2010, Marly Co. should record the bonds with a discount of $5,600.

To calculate the discount, we need to determine the value of the bonds without the warrants, which would sell at 96. Since the face value of each bond is $1,000, the bonds without the warrants would be worth $960.

Therefore, the discount is $1,000 - $960 = $40 per bond. And since Marly Co. issued $500,000 of bonds, the total discount would be $40 * 500 = $20,000.

However, since there were 20 detachable stock warrants attached to each $1,000 bond, the dilutive effect of the warrants needs to be considered. The fair value of each warrant is $2, so the total fair value of the warrants is $2 * 20 = $40. This amount needs to be deducted from the discount, resulting in a net discount of $20,000 - $40 = $5,600.