Question

The manager of a small hotel resort is considering expansion. He would like to issue bonds but do not quite understand why he may or may not receive what amount of money is stated on the face of the bond but he has to repay what is on the face of the face bond. Write a report to the manager explaining the market forces that determine how much money will be collected. Also explain how the interest payment on bonds are calculated and paid.

Answer 1

SOLUTION

The amount received by the company on $ 92639.91.

What are the market forces to determine the how much money is collected

1.Credit rating

2. interest rates

3 Change in maturity date

4 past performance like interest payment or bond repayment etc. these are the few thing will

determine the how much money will collect

Calculating interest expense for bonds sold at a discount

Let's start first with bonds issued at a discount. Small hotel resort. sells $100,000 of five-year bonds

with a semiannual coupon of 5%, or 10% per year. Investors think the company is risky, so they

demand a 12% yield to maturity for buying these bonds.

The first step is to use a finance calculator to calculate how much the company will receive from

selling these bonds by entering the following information into a financial calculator:

Future value: $100,000 (The face value of the bonds).

Number of periods: 10 (5 years of semiannual payments).

Payment: $5,000 (5% semiannual coupon multiplied by the face value).

Rate: 6% (12% yield-to-maturity divided by two semiannual periods).

Solve for the present value.

The result is that the company receives only $92,639.91 from selling these bonds. Thus, the bonds

are sold at a discount of $7,360.09 ($100,000 in face value minus proceeds of $92,639.91).

Interest expense calculations

• Every six months, small hotel resorts. will naturally have to pay its bondholders cash coupons of $5,000. This is clearly interest expense. However, it isn't the only amount recorded as interest expense on a bond sold at a discount.
• The discount on the bonds of $7,360.09 is an additional cost of financing. GAAP requires that the discount is amortized into interest expense over time.
• To calculate the interest expense for the first period, we take the $92,639.91 carrying value of the bonds and multiply it by half the yield-to-maturity. This results in $92,639.91*(0.12/2)=$5,558.39 of interest expense for the first semiannual period.
• The actual cash interest paid was only $5,000 -- the coupon multiplied by the bond's face value. However, interest expense also includes the $558.39 of amortized discount in the first six months.
• To calculate interest expense for the next semiannual payment, we add the amount of amortization to the bond's carrying value and multiply the new carrying value by half the yield to maturity. Here's what the math looks like for the full five-year period.

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