Determining bond prices and interest expense Adams is planning to issue $520,000
ID: 2461927 • Letter: D
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
1.a.At par-value of bond price, total interest expense is equal to interest payment. It means if the bond is offered in the market at its maturity value, the company has to pay interest what calculated.
b. In case of discounted bond price, interest expense is greater than its cash payment. In this case the discount amount should be added with the interest expense to make the interest expense more.
c. If the market interest, 7%, is more than the stated interest rate, 6%, the bond should be issued at discount. Since the market rate is higher, bond should be attracted in the market if offered at lower price, like discount.
2. If the bond is sold in the market at 93, the bond price would be $520,000 93% = $483,600. Since the 100% is $520,000, we have to calculate 93% of it.
3. The company has to pay interest at 6% on the par-value of bond, $520,000. Interest payment is $520,000 6% = $31,200.
Since the bond is offered at discount, the discount amount is the difference of par-value and selling price. $520,000 - $483,600 = $36,400. Since the bond is for 5 years, the amortization amount of each year under straight-line method is $36,400 5 = $7,280. The amount $7,280 is to be added with $31,200 to get the total interest expense. Therefore, the interest expense would be $31,200 + $7,280 = $38,480.
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