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 for your advice on some related matters.

 Requirements

1. Answer the following questions:

a. At what type of bond price Jones Company will have a 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?

Answer 1

Step 1: Definition of the bonds 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.

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.

c.     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.

In the first part, the bonds are issued at par.