Lighthouse Enterprises decided to issue $700,000 of 10-year bonds. The interest

Question

Lighthouse Enterprises decided to issue $700,000 of 10-year bonds. The interest rate on the bonds is stated at 10%, payable semiannually. At the time the bonds were sold, the market rate had increased to 12%.

Instructions:

1. Determine the maximum amount an investor should pay for these bonds. (Note: round to the nearest dollar)

2. assuming the amount in (1) is paid, compute the amount at which the bonds would be reported by the investor after being held for one year. Use two recognized methods of handling amortization of the difference in cost and maturity value of the bonds and give support to the method you prefer. (Note: round to the nearest dollar).

Explanation / Answer

The price that can be paid for the bond = $619707.24

There are two methodsof discount amortisation. One is straight line method and the other is effective interest method. In both methods, the amortisation for the year1 remains the same.

Year Interest pay Discount rate PV factor for 6% Discounted 1 35000 0.060 0.9434 33018.87 2 35000 0.060 0.8900 31149.88 3 35000 0.060 0.8396 29386.67 4 35000 0.060 0.7921 27723.28 5 35000 0.060 0.7473 26154.04 6 35000 0.060 0.7050 24673.62 7 35000 0.060 0.6651 23277.00 8 35000 0.060 0.6274 21959.43 9 35000 0.060 0.5919 20716.45 10 35000 0.060 0.5584 19543.82 11 35000 0.060 0.5268 18437.56 12 35000 0.060 0.4970 17393.93 13 35000 0.060 0.4688 16409.37 14 35000 0.060 0.4423 15480.53 15 35000 0.060 0.4173 14604.28 16 35000 0.060 0.3936 13777.62 17 35000 0.060 0.3714 12997.75 18 35000 0.060 0.3503 12262.03 19 35000 0.060 0.3305 11567.96 20 35000 0.060 0.3118 10913.17 20 700000 0.06 0.3118 218260.00 Value of Bond 619707.24

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