Question

ABC Company issues bonds on January 1, Year 1. The bonds have a par value of $10,000,000, a coupon rate of 10% with interest paid semi-annually on every June 30 and December 31 for 10 years, and the yield on the date of issuance is 8%. Calculate the following:

a. The issuance price on January 1, Year1.

b. The impact on the income statement in Year 1. (Expense or revenue and the amount.)

c. The impact on the statement of cash flows in Year 1. (Section of the statement of cash flows, amount, inflow or outlfow.)

d. The amount of total interest expense over the life of the bonds (hint: you can calculate this without generating an amortization chart.)

e. The carrying value of the bonds on the balance sheet at December 31, Year 1.

Answer 1

Answer a.

Face Value = $10,000,000

Annual Coupon Rate = 10%
Semiannual Coupon Rate = 5%
Semiannual Coupon = 5% * $10,000,000
Semiannual Coupon = $500,000

Annual Yield = 8%
Semiannual Yield = 4%

Time to Maturity = 10 years
Semiannual Period to Maturity = 20

Issue Price = $500,000 * PVIFA(4%, 20) + $10,000,000 * PVIF(4%, 20)
Issue Price = $500,000 * (1 - (1/1.04)^20) / 0.04 + $10,000,000 / 1.04^20
Issue Price = $11,359,033

Answer b.

June 30, Year 1:

Interest Expense = Carrying Value * Semiannual Yield
Interest Expense = $11,359,033 * 4%
Interest Expense = $454,361

Amortization of Premium = Semiannual Coupon - Interest Expense
Amortization of Premium = $500,000 - $454,361
Amortization of Premium = $45,639

Carrying Value = $11,359,033 - $45,639
Carrying Value = $11,313,394

December 31, Year 1:

Interest Expense = Carrying Value * Semiannual Yield
Interest Expense = $11,313,394 * 4%
Interest Expense = $452,536

Amortization of Premium = Semiannual Coupon - Interest Expense
Amortization of Premium = $500,000 - $452,536
Amortization of Premium = $47,464

Carrying Value = $11,359,033 - $47,464
Carrying Value = $11,311,569

Interest Expense reported on Income Statement = $454,361 + $452,536
Interest Expense reported on Income Statement = $906,897

Answer c.

Cash Flows from Operating Activities:

Interest Paid = $500,000 + $500,000
Interest Paid = $1,000,000

Cash Flows from Financing Activities:

Issuance of Bonds = $11,359,033

Answer d.

Total Interest Expense = Total Interest Paid + Maturity Value - Amount borrowed
Total Interest Expense = 20 * $500,000 + $10,000,000 - $11,359,033
Total Interest Expense = $10,000,000 + $10,000,000 - $11,359,033
Total Interest Expense = $8,640,967

Answer e.

Carrying Value of the bonds on balance sheet is $11,311,569