Corporation is considering issuing bonds on January 1, 2009, and has asked your advice concerning several matters. The firm plans to issue $800,000 of 30-year, 10 percent bonds. Bond interest payments are on January 1 and July 1.
IfthebondsareissuedonJanuary1,2009,atapriceof91.275whenthe market interest rate is 11 percent, how much cash will the firm receive? Explain to the president of the corporation the amount of interest expense the firm will report on their income statement during the first year and how much cash will be paid in interest during that time.
To calculate the amount of cash the firm will receive from the bond issuance, you need to multiply the face value of the bonds by the price at which they will be issued.
The face value of the bonds is $800,000.
The price at which the bonds will be issued is given as 91.275. This means that for every $100 face value of bonds, the firm will receive $91.275.
To calculate the cash received, you can use the following formula:
Cash received = Face value of bonds * Price at issuance
Cash received = $800,000 * 91.275/100
Cash received = $730,200
Therefore, the firm will receive $730,200 in cash from the bond issuance.
Now let's calculate the interest expense on the income statement and the cash paid in interest during the first year.
The interest expense on the income statement can be calculated by multiplying the carrying value of the bonds at the beginning of the period by the market interest rate.
The carrying value of the bonds is the initial cash received from the issuance minus any premium or plus any discount amortized over the life of the bond.
In this case, since the bonds are issued at a price of 91.275, which is lower than the face value, there is a discount involved. The discount represents the difference between the face value and the issue price.
The discount amount can be calculated by subtracting the issue price from the face value:
Discount = Face value - Issue price
Discount = $800,000 - $730,200
Discount = $69,800
To calculate the carrying value of the bonds at the beginning of the period, you subtract the discount from the face value:
Carrying value = Face value - Discount
Carrying value = $800,000 - $69,800
Carrying value = $730,200
Now, to calculate the interest expense, you multiply the carrying value by the market interest rate:
Interest expense = Carrying value * Market interest rate
Interest expense = $730,200 * 11%
Interest expense = $80,322
So, the firm will report $80,322 as interest expense on its income statement during the first year.
To calculate the cash paid in interest during that time, you multiply the face value of the bonds by the annual coupon rate:
Cash paid in interest = Face value * Annual coupon rate
Cash paid in interest = $800,000 * 10%
Cash paid in interest = $80,000
Therefore, the firm will pay $80,000 in cash as interest during the first year.