Question

 

Question: Determining bond prices and interest expense

Jones Company is planning to issue $490,000 of 9%, five-year bonds payable to

borrow for a major expansion. The owner, Shane Jones, asks your advice on some

related matters.

Requirements

1. Answer the following questions:

a. At what type of bond price Jones Company will have total interest expense

equal to the cash interest payments?

b. Under which type of bond price will Jones Company’s total interest expense be

greater than the cash interest payments?

c. If the market interest rate is 12%, what type of bond price can Jones Company

expect for the bonds?

2. Compute the price of the bonds if the bonds are issued at 89.

3. How much will Jones Company pay in interest each year? How much will Jones

Company’s interest expense be for the first year?

Answer 1

 

Step 2: Type of the bonds

a.    When the total interest expense is equal to the cash interest payments, this type of bond is known as the issue at par.

b.    When the total interest expense is greater than the cash interest payment, this type of bond is known as bonds issued at a discount.

If the market interest rate is 12%, then the bonds are issued at a discount because the market interest rate exceeds the bond issue interest rate.

 

Step 2: Calculation of the price of bonds

In the given question, bonds are issued at 89, which means the bonds are issued at a discount

 

When the interest rate of the bonds is less than the market interest rate, this type of bond is known as bonds issued at a discount.