How could the repurchase of debt cause a loss

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Reference no: EM133611946

Question: On January 1, 2020, West-Tex Oil issued $50 million of 8% bonds maturing in 10 years. The market interest rate on the issue date was 9%, which resulted in the bonds being issued at a discount. In December 2021, Tex Winters, the company CFO, notes that in the two years since the bonds were issued, interest rates have fallen almost 3%. Tex suggests that West-Tex might consider repurchasing the 8% bonds and reissuing new bonds at the lower current interest rates.

Another executive, Will Bright, asks, "Won't the repurchase result in a large loss to our financial statements?" Tex agrees, indicating that West-Tex is likely to just meet earnings targets for 2021. The company would probably not meet its targets with a multimillion-dollar loss on a bond repurchase. However, 2022 looks to be a record-breaking year. They decide that maybe they should wait until 2022 to repurchase the bonds.

How could the repurchase of debt cause a loss to be reported in net income? Explain how the repurchase of debt might be timed to manage reported earnings. Is it ethical to time the repurchase of bonds to help meet earnings targets?

Reference no: EM133611946

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