Stower's Research issues bonds dated Jan.1,2005 that pay interest semiannually on June 30and Dec.31. The bonds have a $20,000 par value, an annual contract rate of 10% and mature in 10 years. For each of the following, determine the bonds price on Jan. 1, 2005 and prepare the journal entry to record their issuance: 1) market rate at date of issuance of 8%,10%and 12%. Please help.
To determine the bond's price on January 1, 2005, we need to calculate the present value of the future cash flows (interest and principal) the bond will generate. The present value is calculated using discounted cash flow analysis, where the cash flows are adjusted for the prevailing market interest rates.
To calculate the bond's price at different market rates, you will need to use the following formula:
Bond Price = PV of Interest Payments + PV of Principal Payment
1) Market rate at the date of issuance is 8%:
Step 1: Calculate the present value of interest payments:
PV of Interest Payments = (Annual Contract Rate × Par Value) × Present Value Factor
PV of Interest Payments = (10% × $20,000) × (1 - (1 / (1 + 8%)^20)) / 8%
PV of Interest Payments = $2,000 × 9.8186
PV of Interest Payments = $19,637.20
Step 2: Calculate the present value of the principal payment:
PV of Principal Payment = Par Value × Present Value Factor
PV of Principal Payment = $20,000 × (1 / (1 + 8%)^20)
PV of Principal Payment = $20,000 × 0.4564
PV of Principal Payment = $9,128
Bond Price = PV of Interest Payments + PV of Principal Payment
Bond Price = $19,637.20 + $9,128
Bond Price = $28,765.20
The bond's price on January 1, 2005, when the market rate is 8%, is $28,765.20.
To record the issuance of the bond in a journal entry, we need to debit the cash received and credit the bonds payable for the bond's price:
Jan. 1, 2005:
Dr. Cash $28,765.20
Cr. Bonds Payable $28,765.20
You will perform similar calculations for market rates of 10% and 12% to determine the bond's price on January 1, 2005, and record the journal entries.