- This topic has 1 reply, 2 voices, and was last updated Jan-21 by
.
-
Posts
-
-
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)
-
$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
-
- You must be logged in to reply to this topic.