Part 1: If a company decided to issue a bond to raise cash for the construction
ID: 2471129 • Letter: P
Question
Part 1: If a company decided to issue a bond to raise cash for the construction of a new distribution center, 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. Utilize the present value (PV) function within Excel to calculate the proceeds.
Part 2: What amount of interest expense will be recognized each year of the bond and what is the total amount of interest expense over the life of this bond? Utilize formulas within Excel to prepare an effective interest method amortization schedule for the life of the bond.
Part 3: In regards to this bond, what amount of gain or loss, if any, would need to be recorded by the company on January 1, 2017 when market rates have changed to 6% if the bond was originally sold on January 1, 2016 using the fair value option?
I am most confused on Parts 2 and especially 3. I believe the answer to Part 1 is $15,011,152.33 using the Excel PV funtion.
Explanation / Answer
Solution:
Par Value of Bond = $12,775,000
Coupon Rate (Annually) = 9% or 4.5% semi annually
Coupon Interest Amount to be paid on each interest payment date = $12,775,000 x 4.5% = $574,875
Life of Bond = 5 years
No. of payments to be done during the life of bond = 5 x 2 = 10
Market Rate = 5% annually or 2.5% semi-annually
Issue Price of Bond = Coupon Interest x PVIFA (Market Rate, 10) + Maturity value x PVIF (Market Rate, 10)
= $574,875 x PVIFA (2.5%, 10) + $12,775,000 x PVIF (2.5%, 10)
= ($574,875 x 8.75206) + ($12,775,000 x 0.781198)
= $5,031,343 + $9,979,810
= $15,011,153
Since, Issue price is high than par value, bonds are issued at premium.
Premium on Bonds Payable = Issue Price - Par Value = $15,011,153 - $12,775,000 = $2,236,153
Company uses effective interest method to amortize the bond premium.
Part 1: The amount proceeds received by the company from issuance of bonds = $15,011,153
Part 2: Schedule of Bond Interest Expenses to be recognized each year / with each payment of Interest and total amount of interest payable over the life of bond.
Payment intervals
Date
Bond Interest to be paid to Bond Holders (Par Value x Coupon Rate Semi Annually)
Bond Interest Expenses (Beginning Book Value @ 2.5% Market Rate)
Amount of Bond Premium to be Amortized with each interest payment (Bond Interest Payable – Bond Interest Expenses)
Balance of Unamortized Bond Premium A/c
Par Value of Bonds Payable
Book Value (Par Value + Balance of Unamortized Bond Premium)
0
$2,236,153
$12,775,000
$15,011,153
1
1-Jul-16
$574,875
$375,279
$199,596
$2,036,557
$12,775,000
$14,811,557
2
31-Dec-16
$574,875
$370,289
$204,586
$1,831,971
$12,775,000
$14,606,971
3
1-Jul-17
$574,875
$365,174
$209,701
$1,622,270
$12,775,000
$14,397,270
4
31-Dec-17
$574,875
$359,932
$214,943
$1,407,327
$12,775,000
$14,182,327
5
1-Jul-18
$574,875
$354,558
$220,317
$1,187,010
$12,775,000
$13,962,010
6
31-Dec-18
$574,875
$349,050
$225,825
$961,185
$12,775,000
$13,736,185
7
1-Jul-19
$574,875
$343,405
$231,470
$729,715
$12,775,000
$13,504,715
8
31-Dec-19
$574,875
$337,618
$237,257
$492,458
$12,775,000
$13,267,458
9
1-Jul-20
$574,875
$331,686
$243,189
$249,269
$12,775,000
$13,024,269
10
31-Dec-20
$574,875
$325,607
$249,268
$1
$12,775,000
$12,775,001
Total:
$5,748,750
$3,512,598
$2,236,152
$10,517,762
Part 3:
We need to calculate the current market price of bond as on January 1, 2017 when market rate changed to 6% per annum or 3% semi-annually.
Market Price of Bonds as on January 1, 2017 = Coupon Interest x PVIFA (3%, 8) + Maturity Value x PVIF (3%, 8)
= ($574,875 x 7.019692) + ($12,775,000 x 0.789409)
= $4,035,446 + $10,084,703
= $14,120,149
Bonds are sold for $14,120,149
Carrying Value of Bonds as on Jan 1, 2017 (from the above table) = $14,606,971
Since the selling amount of bonds are less than carrying value, the loss on bonds to be recorded = $14,120,149 - $14,606,971 = $486,822
Payment intervals
Date
Bond Interest to be paid to Bond Holders (Par Value x Coupon Rate Semi Annually)
Bond Interest Expenses (Beginning Book Value @ 2.5% Market Rate)
Amount of Bond Premium to be Amortized with each interest payment (Bond Interest Payable – Bond Interest Expenses)
Balance of Unamortized Bond Premium A/c
Par Value of Bonds Payable
Book Value (Par Value + Balance of Unamortized Bond Premium)
0
$2,236,153
$12,775,000
$15,011,153
1
1-Jul-16
$574,875
$375,279
$199,596
$2,036,557
$12,775,000
$14,811,557
2
31-Dec-16
$574,875
$370,289
$204,586
$1,831,971
$12,775,000
$14,606,971
3
1-Jul-17
$574,875
$365,174
$209,701
$1,622,270
$12,775,000
$14,397,270
4
31-Dec-17
$574,875
$359,932
$214,943
$1,407,327
$12,775,000
$14,182,327
5
1-Jul-18
$574,875
$354,558
$220,317
$1,187,010
$12,775,000
$13,962,010
6
31-Dec-18
$574,875
$349,050
$225,825
$961,185
$12,775,000
$13,736,185
7
1-Jul-19
$574,875
$343,405
$231,470
$729,715
$12,775,000
$13,504,715
8
31-Dec-19
$574,875
$337,618
$237,257
$492,458
$12,775,000
$13,267,458
9
1-Jul-20
$574,875
$331,686
$243,189
$249,269
$12,775,000
$13,024,269
10
31-Dec-20
$574,875
$325,607
$249,268
$1
$12,775,000
$12,775,001
Total:
$5,748,750
$3,512,598
$2,236,152
$10,517,762