Katarina Witt, Inc. manufactures skating equipment. Recently the Vice President
ID: 2470237 • Letter: K
Question
Katarina Witt, Inc. manufactures skating equipment. Recently the Vice President of Operations of the company has requested construction of a new plant to meet the increasing needs for the company's skates. After a careful evaluation of the request, the board of directors has decided to raise funds for the new plant by issuing $2,000,000 of 11% term corporate bonds on January 1, 2006, due on January 1, 2016, with interest payable each January 1 and July 1. At the time of issuance, the market interest rate for similar financial instruments is 10%. As the controller of the company, determine the selling price of the bonds (round to the nearest one): Did the bonds sell at a premium or discount? Determine the amount of Premium/Discount at date of issuance:Explanation / Answer
Answer:
a) Selling price of the bond = $2,124,820
Workings:
Present value annuity factor for 20 periods @5% = [{ 1 - (1/1.05)^20 } / 0.05 = 12.462
Present value factor for 20th period @5% = 0.377
Therefore, Selling Price = PVAF (Coupon amount for 6 months) + PVIF (Maturity amount)
= 12.462 (110,000) + 0.377 (2,000,000) = $2,124,820
b) Bonds sell at premium as selling price is more than maturity amount i.e. 2,124,820 > 2,000,000.
c) Bonds sell at premium = Selling price - Maturity amount = 2,124,820 - 2,000,000 = $124,820
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