Determining bond prices and interest expense Adams is planning to issue $520,000

Question

Determining bond prices and interest expense

Adams is planning to issue $520,000 of 6%, five-year bonds payable to borrow for a major expansion. The owner, Shane Adams, asks your advice on some related matters.

Requirements

Answer the following questions:

At what type of bond price will Adams’s total interest expense equal to the cash internet payments?

Under which type of bond price will Adams’s total interest expense be greater than the cash interest payments?

If the market interest is 7% what type of bond price can Adams expect for the bonds?

Compute the price of the bonds if the bonds are issued at 93.

How much will Adams pay in interest each year? How much will Adams’s interest expense be for the first year?

Explanation / Answer

Ans 1 When interest rate of the bond and market value is same than the interest expense and cash interest payment will be same Price of the bond will be the par value $520,000 Ans 2 When bonds are issue at discount than interest expense is greater than cash interest payment This means market rate is more than bond interest rate so it is issued on discount The entry is Interest Expense Dr Cash Cr Discount on issue of Bond Payable (Amortized) Cr So bond price is less than $520000 Ans 3 Note Price of the bond = c × F × (1 (1 + r)-t)/r+F(1 + r)t C=Interest Rate F= Face Value r=Market Interest Rate Price of Bond= Present value of Interest payments+Present value of the bond Price of Bond ((520000*.06)*(1-(1.07)^-5))/.07)+520000/(1.7)^5 31200*(1-.7130)/.07)+520000*..7130 498680 Ans the bond price is on discount Ans 4 Price of the bond is $520000/100*93 483600 cash interest payment is $520000*.06 31200 Interest expense will be Interest Rate * 483600 483600*7.75% 37479 Date Interest Payment @6% Bond Interest expenses at 7.75%*G Discount Amortization of Bond C-B Unamortized discount Credit balance in the Bond payable Carrying value of Bond F-E Credit cash Debit Interest Expense Bond Discount Year 0 36400 520000 483600 Year 1 31200 37479 6279 30121 520000 489879 Year 2 31200 37966 6766 23355 520000 496645 Year 3 31200 38490 7290 16065 520000 503935 Year 4 31200 39055 7855 8210 520000 511790 Year 5 31200 39664 8464 -253 520000 520253

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