Question

On January 1, 2018, Corp X issued 3%, 3 ½ year Bonds to the public, and also signed a 3 and 1/2 -year lease with PH Corp. Payments of $10,000 on the lease are made at the end of the year for years 1,2 and 3 and ($5,000 in the last period; year 4.) There are no provisions for a bargain purchase or an extension of the lease term. The asset has a fair value of $35,000 and has a useful economic life of 4 years.

Corp. X is rated as a BBB rated company by Moody’s Investors-a rating company.

Additional Facts

1-BBB Market Interest rates:

Date of issue                         on 12/31/2019

Year 1     2%                               1.5%

Year 2    2.5%                            2.0%

Year 3    2.75%                          2.5%

Year 4    3,5%                             3.0%

Year 5     4.0%.                           4.0%

BTW There is no correct answer

Question 7

1-Calculate the market interest rate at date of issue?

2-Calculate the price of the bond at the date of issue?

3-What is the interest expense in Year 1.

4-What is the Balance Sheet value of Bonds payable on 12/31/19? Please provide 2 answers.

Answer 1

Solution

* For issue price of Bond

Corp X issued 3% bonds for 3 & 1/2 year and market interest rate is 3.5% for BBB rated company

Let the face value of Bond be 100 $

YEAR	CASH FLOW ($)	TYPE	DISCOUNTING FACTOR(3.5%,4)	PRESENT VALUE ($)
1	3	INTEREST	0.9661	2.90
2	3	INTEREST	0.9335	2.80
3	3	INTEREST	0.9019	2.71
4	3	INTEREST	0.8714	1.31
4	100	REPAYMENT	0.8714	87.14
			TOTAL	96.85 $

Hence, the issue price of the 3 & 1/2 year bond of face value 100$ is 96.85 $

1) The market interest rate at date of issue = 3/96.85*100 = 3.10%

2) The issue price of the bond at the date of issue = fair value = 96.85$

3) Interest expense in year 1 = 3 ( 3/96.85*100 = 3.10%) (FOR PER BOND OF 100$ ISSUED AT 96.85$)

4)value of bond in balance sheet as on 12/31/19 (fair value)

Market Interest Rate for 3 Year bond of BBB rated company is 2.5%

YEAR	CASH FLOW ($)	TYPE	DISCOUNTING FACTOR(2.5%,3)	PRESENT VALUE ($)
1	3	INTEREST	0.9756	2.93
2	3	INTEREST	0.9518	2.86
3	3	INTEREST	0.9286	2.79
3	100	REPAYMENT	0.9286	92.86
			TOTAL	101.43 $

Balance Sheet value of Bonds payable on 12/31/19 IS 101.43$ (FAIR VALUE)