Question

On January 1, 2018, Brussels Inc. will issue $5,000,000 in bonds that mature in ten years. The bonds have a stated interest rate of 10% and will pay interest every June 30 and December 31 of each year. Brussels will adopt the straight line amortization method for calculating interest charges per year.

REQUIRED: 1. What is the annual interest expense Brussels will have to pay in cash each year?

2. Calculate the cash proceeds of the bond sale if the market rate is 4%. Show your work.

3. Calculate the cash proceeds of the bond sale if the market rate is 20%. Show your work.

4. Present the journal entry Brussels must record at the time of issuance of the bonds when the market rate is 20%. 5. How much will Brussels have to pay in cash in order to retire the bonds when they mature under a market rate of 20% - for this answer do not include the final interest payment

6. Using a market rate of 10%, what will the total amount of interest per year Brussels will have to be charged? Show your work.

7. Explain the cause of the following statement – “When interest rate fall bonds prices increase and when interest rate rise bonds prices fall. Interest rates and bond prices are inversely related.

8. What is the impact of having to amortize the discount on Brussels Statement of Cash Funds Flows – assume Brussels adopt the Indirect Method for its presentation of the Statement of Cash Funds Flow?

Answer 1

1. Annual interest expense that Brussels will have to pay in cash each year = $ 5,000,000 x 10 % = $ 500,000.

2. If the market rate is 4 %,

Cash proceeds from the issue of bonds = $ 250,000 x 16.3514 + $ 5,000,000 x 0.6730 = $ 4,087,850 + $ 3,365,000 = $ 7,452,850.

n = 10 x 2 = 20, r = 4 % x 1/2 = 2 % , Coupon = $ 250,000, Par Value = $ 5,000,000

PVIFA _{2%, 20} = [ { 1 - ( 1 / 1.02) ²⁰ } / 0.02 ] = 16.3514

PVIF, _{2% ,20} = ( 1 / 1.02) ²⁰ = 0.6730

3. If the market rate is 20 %,

Cash proceeds form the issue of bonds = $ 250,000 x 8.5136 + $ 5,000,000 x 0.1486 = $ 2,128,400 + $ 743,000 = $ 2,871,400.

n = 20, r = 20 % x 1/2 = 10 %, Coupon = $ 250,000, Par Value = $ 5,000,000

PVIFA _{10%, 20} = [ { 1 - ( 1 / 1.10 ) ²⁰ } / 0.10 ] = 8.5136

PVIF _{10%, 20} = ( 1 / 1.10 ) ²⁰

4.

Date	Account Titles	Debit	Credit
		$	$
January 1, 2018	Cash	2,871,400
	Discount on Bonds Payable	2,128,600
	Bonds Payable		5,000,000

5. Brussels will have to pay $ 5,000,000 in cash to retire the bonds.

6. If the market rate of interest is 10 % ( i.e the same as the coupon rate ), the total amount of interest charged per year =

$ 500,000.