Question

Lawrence Keen is the President of the Safe Water Filter Company. As President, he is in control of the issuance of stocks and Bonds. Three years ago when the company needed purchased from the company a $100,000, 4 percent, 10-year unsecured bond. The interest rate has begun to increase. Lawrence suggests that the company refinance the bonds to extend the life of the bonds, even though the interest rate has increased to 7 percemt cash, Lawrence Using the following formula: I- Principal Rate Time Legacy Financing 1 = $100,000 * 4% * 10 = $40,000 Proposed Financing: I- $100,000 7% 10 $70,000 If the legacy financing arrangement was in place for the entire 10-year period, Mr. Keen would have earned $40,000 in interest income. However, if the company refinances for a longer term and at a higher rate, it will allow Mr. Keen the opportunity to earn $70,000 over 10 years. Does allowing Mr. Keen the opportunity to earn additional interest income under the revised financing agreement create a conflict of interest? Why or why not? Does your answer change if SWFC is owned only by Mr. Keen? What if he was one of many owners? Does your answer change if he's a proprietor vs a partner? What affect would having a higher interest rate on bonds have on the net income of SWFC?

Answer 1

From the above pbm there is an interest conflict, since Mr. K can't earn $70,000 through interest. The new rate is in place after the completion of 3 years. The term of the bond is 10 years. Therefore, there is only (10-3 )7 years left. The Additional income- New income - Old income = ($100,000 x 796 x 7)-($100,000 x 4% x 7) = 49,000-28,000 = $21,000