CFA CFA Level 1 int expense

int expense

  • This topic has 1 reply, 2 voices, and was last updated Jan-21 by rahul12.
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    • pcunniff
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      Hey! Where are they getting $10,366 from? Would appreciate any help here!

      Assume a city issues a $5 million semiannual-pay bond to build a new arena. The bond has a coupon rate of 8% and will mature in 10 years. When the bond is issued its yield to maturity is 9%. Interest expense in the second semiannual period is closest to:

      A)

      $80,000.

      B)

      $210,830.

      C)

      $106,550.

      Step 1: Compute the proceeds raised (i.e., the present value of the bond): Since the yield is above the coupon rate the bond will be issued at a discount.

      FV = $5,000,000; N = (10 × 2) = 20; PMT = (0.08 / 2)(5 million) = $200,000; I/Y = (9 / 2) = 4.5; CPT → PV = -$4,674,802

      Step 2: Compute the interest expense at the end of the first period.

      = (0.045)(4,674,802) = $210,366

      Step 3: Compute the interest expense at the end of the second period.

      = (new balance sheet liability)(current interest rate)

      = $4,674,802 + $10,366 = $4,685,168 new balance sheet liability

      (0.045)(4,685,168) = $210,833

      (Study Session 8, Module 28.2, LOS 28.b)

    • rahul12
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      $10,366 is the difference between the interest expense at the end of year 1 ($210,366) and the coupon payment ($200,000).

      you need to adjust the balance sheet’s bond liability end of 1st period to calculate 2nd period’s interest expense.

      the ending bond liability = beginning bond liability ($4,674,802) + change in bond liability ($210,366 – 200,000) = $4,685,168

      therefore, 2nd period’s interest expense is 4.5% x 4,685,168 = $210,833

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