Part 1: If the company decided to issue a bond to raise cash for the constructio
ID: 2465417 • Letter: P
Question
Part 1: If the company decided to issue a bond to raise cash for the construction of the new DC, what would be the amount of proceeds received by the company if on January 1, 2016 the company issues $12,775,000 in 9% coupon bonds due December 31, 2020 with semi-annual interest payments due July 1 and December 31 each year? Assume the market rate is 5% for companies with risk profiles similar to the company. Part 2: In regards to this bond, what amount of gain or loss, if any, would need to be recorded by the company if the bond was originally sold January 1, 2016 and the fair value option is applied for the first time on January 1, 2017 when market rates have changed to 6%?
Explanation / Answer
1) The proceeds would be the PV of the cash outflows from the bond, discounted at 5%.
PV = 12775000*PVIF(2.5,10) + 574875*PVIFA(2.5,10)
=12775000*0.7812 + 574875*8.7521 = $15,011,193.
The bonds have been issued at a premium, the journal entry on date of issue being
Cash ..............................15,011,193
Premium on Bonds payable...........................2,236,193
Bonds payable...............................................12,775,000
On July 1st for interest payment
Interest expense .........................375,280
Premium on bonds payable.......199.595
Cash.....................................574,875
On December 31, for accruing of interest
Interest expense .........................370,290
Premium on bonds payable.......204,585
Cash.....................................574,875
The carrying value of the bonds as on 1.1.2017
Bonds payable = 12,775,000
add: premium on bonds = 1,832,013
Book Value = 14,607,013
Fair value of the bonds as on 1.1.2017 when interest rate is changed to 6%
PV = 12775000*PVIF(3,8) + 574875*PVIFA(3,8)
=12775000*0.7894 + 574875*7.0197 = $14,120,035
Therefore, the gain to be recorded by the company will be 14,607,013 - 14,120,035 = $486,978