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Assessing Debt Financing, Company Interests, and Managerial Ethics Foster Corporation is in the third quarter of the current year, and projections are that net income will be down about $600,000 from the previous year. Foster's return on assets is also projected to decline from its usual 15% to approximately 13%. If earnings do decline, this year will be the second consecutive year of decline. Foster's president is quite concerned about these projections C9-61. (and his job) and has called a meeting of the firm's officers for next week to consider ways to "turn things around-and fast." Margot Barth, treasurer of Foster Corporation, has received a memorandum from her assis tant, Lorie McNichols. Barth had asked McNichols if she had any suggestions as to how Foster might improve its earnings performance for the current year. McNichols' memo reads as follows As you know, we have $3,000,000 of 4%, 20-year bonds payable outstanding. We issued these bonds 10 years ago at face value, so they have 10 years left to maturity. When they mature, we would probably replace them with other bonds. The economy is expecting a period of greater inflation, and interest rates have increased to about 8%. My proposal is to replace these bonds right now. More specifically, I propose 1. 2. 3. Immediately issue $3,000,000 of 20-year, 8% bonds payable. These bonds will be issued at face value Use the proceeds from the new bonds to buy back and retire our outstanding 4% bonds. Because of the current high rates of interest, these bonds are trading in the market at about $2,200,000 The benefits to Foster are that (a) the retirement of the old bonds will generate an $800,000 gain for the income statement and (b) there will be an extra $800,000 of cash available for other uses. Barth is intrigued by the possibility of generating an $800,000 gain for the income statement However, she is not sure this proposal is in the best long-run interests of the firm and its stockholde REQUIRED a. How is the $800,000 gain calculated from the retirement of the old bonds? Where would this gain be reported in Foster's income statement? Why might this proposal not be in the best long-run interests of the firm and its stockholde What possible ethical conflict is present in this proposal? b

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