on 1 july 2018 power ltd issues $10 million in five year denentures that pay interest...

on 1 july 2018 power ltd issues $10 million in five year denentures that pay interest each 6 months at coupon rate of 5%. at the time of issuing the securities the market requires a raye of return of 8%. interest expense id determined using the effective interest method.

required:

a) determine if the debenture is issued premium or discount?

b) determine the fair value of the debentures?

corporation and financial accounting

Expert Solution

Debentures are said to be issued at premium when their coupon rate is more than the expected rate of return in the market. Debentures are said to be issued at discount when their coupon rate is less than the expected rate of return in the market.

a) In the given question, Coupon rate of debentures issued by Power Ltd. is 5.00% and the expected rate of return in the market is 8%. Hence, the debentures are issued at a discount.

b) Fair value of debentures is the present value of the future receives from the debentures which include the coupon payments and the principal received on maturity. The current market rate i.e. 8.00% is considered as the rate for discounting the future receivables.

As the coupon rate is 5.00% and interest is paid every six months and the tenure of the debentures is 5 years, we shall consider 10 periods with interest payment at the rate of 2.50%.

	A	B	C	D	E
	(10 Mn. X 2.5%)		A + B		C x D
Period	Interest received	Principal received	Total receipts	PVF @ 8.00%	Present value
1	$250,000	-	$250,000	0.926	$231,481
2	$250,000	-	$250,000	0.857	$214,335
3	$250,000	-	$250,000	0.794	$198,458
4	$250,000	-	$250,000	0.735	$183,757
5	$250,000	-	$250,000	0.681	$170,146
6	$250,000	-	$250,000	0.630	$157,542
7	$250,000	-	$250,000	0.583	$145,873
8	$250,000	-	$250,000	0.540	$135,067
9	$250,000	-	$250,000	0.500	$125,062
10	$250,000	$10,000,000	$10,250,000	0.463	$4,747,733
Total	$2,500,000	$10,000,000	$12,500,000		$6,309,455

As seen from the above table, the fair value of debentures is $6,309,455.

ekkarill92 answered 2 years ago

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