long term liabilities Requirement 3: When a company exchanges a long-term non-in
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long term liabilities
Requirement 3: When a company exchanges a long-term non-interest bearing note for cash how does the company determine the effecive interest rate? Requirement 4: On January 1, Big Red Inc. issues 10%, 5 year bonds with a face value of $150,000 when the effective interest rate is 12%. Interest is to paid semiannually. Perform computation of the bond issuance price using a financial calculator. For credit, identify financial calculator keys used and their corresponding inputs.Explanation / Answer
Calculation od interest rate on non- interest bearing bonds:
Zero interest bonds are those bonds on which interest is not paid regularly but which include the interest element in the difference between the issue price and the face value (maturity value ) of the bonds.
To calculate the rate of return, divide the face value by the initial price of the bond. Then take that number and raise it to the power of 1 divided by the number of years of the bond's term. Subtract 1 from the final answer, and that will give you the annual rate of return.
For instance, say a zero coupon bond is issued for $800 and will pay $1,000 at maturity 10 years from now. Dividing $1,000 by $800 gives 1.25, and 1.25 raised to the 1/10th power gives 1.0226. Subtract 1, and you're left with 0.0226, or 2.26%.
Calculation of Bond -isuance price:
Face value of the bond = $150,000
Semi-annual interest = $7,500 ($150,000 x 10% / 2)
Effective interest rate = 12%
Semiannual efective interest = 6%
Present value of an annuity (interest) received for 10 periods (5 semi-annual payments) at 6% = 7.36
Present Value of the semi-annula interest of $7,500 = 7,500 x 7.36 = $55,200 ------------ A
Present value of a sum to be received after 5 years at a rate of interest 6% = 0.5674
Present value of $150,000 to be received after 5 years = 150,000 x 0.5674 = 85,110 --------------- B
Issue price of the bond = A+B = $55,200 + $85,110 = $140,310.
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