Question

Turkey Company is seeking to borrow some money on a long-term basis. This firm is considering pursuing one of two alternatives: (1) issuing fifty bonds with a face amount of $1,000 each and (2) signing a long-term note payable for $55,000. Assume that both alternatives would provide cash to Turkey on December 31, Year 1.

The terms of the two alternatives are presented below:

1. The bonds would have a coupon rate of 9% and a market rate [effective rate] of 8%. The bonds would pay interest semiannually on June 30 and December 31.   The bonds would have a maturity date of December 31, Year 11.
2. The note payable would have an interest rate of 8% and would be paid off in 24 equal semi-annual installments starting six months after December 31, Year 1.

Required:

1. How much cash would each alternative provide to Turkey on Dec. 31, Year 1?

Bonds $_________

Note $__________

2. What interest expense would the firm recognize in Year 2 under both alternatives?

Bonds $_________

Note $__________

3. How much cash would Turkey have to pay out during Year 3 if it chose to issue the Bond Payable?

­­­­­$____________

4. How much cash would Turkey have to pay out in Year 3 if it chose to borrow the money using the long-term Note Payable?

$____________

5. What wold the carrying value of the Note Payable be on December 31, Year 5, after the eighth loan payment that would be made on that date?

$________________

Answer 1

Cash proceeds-Bonds:
Cash proceeds of the bond=Present value of interest payment+Present value of principal repayment
Interest payment=Bond face value*Coupon rate=2090000*11%=$ 229900
Bond face value=Number of bonds*Face amount=50*1000=$ 50000
Interest payment per semi-annual period=50000*9%*(6/12)=50000*4.5%=$ 2250
Issued on Dec 31, Year 1
Maturity date on Dec 31,Year 11
Life of the bond=10 years
Number of semi-annual periods=10*2=20 years
Discount rate=Market rate for 6 months=8%*(6/12)=4%
Present value of interest payments=94050* PVIAF @ 4% for 20 years=2250*13.59033=$ 30578
Present value of principal repayment at the end of 20th year=50000*0.45639=$ 22820
Cash proceeds of the bond=30578+22820=$ 53398
Cash proceeds-Note:
Cash proceeds=Face value of note=$ 55000
Bond amortization schedule:
Date	Cash paid	Interest expense	Premium amortizaton	Carrying amount of bonds
	(Interest payment per semi-annual period)	(Previous carrying amount)*4%		(Previous carrying amount- c)
	a	b	c=a-b
Dec 31,Year 1				53398
June 30,Year 2	2250	2136	114	53284
Dec 31,Year 2	2250	2131	119	53165
June 30,Year 3	2250	2127	123	53042
Dec 31,Year 3	2250	2122	128	52914
June 30,Year 4	2250	2117	133	52780
Dec 31,Year 4	2250	2111	139	52641
June 30,Year 5	2250	2106	144	52497
Dec 31,Year 5	2250	2100	150	52347
June 30,Year 6	2250	2094	156	52191
Dec 31,Year 6	2250	2088	162	52028
June 30,Year 7	2250	2081	169	51859
Dec 31,Year 7	2250	2074	176	51684
June 30,Year 8	2250	2067	183	51501
Dec 31,Year 8	2250	2060	190	51311
June 30,Year 9	2250	2052	198	51114
Dec 31,Year 9	2250	2045	205	50908
June 30,Year 10	2250	2036	214	50695
Dec 31,Year 10	2250	2028	222	50472
June 30,Year 11	2250	2019	231	50241
Dec 31,Year 11	2250	2009	241	50000
Discount rate for note=8%*(6/12)=4% (Since equal semi-annual installment)
Monthly installment payment of note=Face value of note/Discount factor at 4% for 24 years=55000/15.24696=$ 3607.8=$ 3608
Note amortization schedule:
Date	Installment paid	Interest expense	Principal repayment	Carrying amount of note
		(Previous carrying amount)*4%		(Previous carriying amount- c)
	a	b	c=a-b
Dec 31,Year 1				55000
June 30,Year 2	3608	2200	1408	53592
Dec 31,Year 2	3608	2144	1464	52128
June 30,Year 3	3608	2085	1523	50605
Dec 31,Year 3	3608	2024	1584	49021
June 30,Year 4	3608	1961	1647	47374
Dec 31,Year 4	3608	1895	1713	45661
June 30,Year 5	3608	1826	1782	43879
Dec 31,Year 5	3608	1755	1853	42026
June 30,Year 6	3608	1681	1927	40099
Dec 31,Year 6	3608	1604	2004	38095
June 30,Year 7	3608	1524	2084	36011
Dec 31,Year 7	3608	1440	2168	33844
June 30,Year 8	3608	1354	2254	31589
Dec 31,Year 8	3608	1264	2344	29245
June 30,Year 9	3608	1170	2438	26807
Dec 31,Year 9	3608	1072	2536	24271
June 30,Year 10	3608	971	2637	21634
Dec 31,Year 10	3608	865	2743	18891
June 30,Year 11	3608	756	2852	16039
Dec 31,Year 11	3608	642	2966	13072
June 30,Year 12	3608	523	3085	9987
Dec 31,Year 12	3608	399	3209	6779
June 30,Year 13	3608	271	3337	3442
Dec 31,Year 13	3608	166	3442	0
Interest expense for year 2:		(Refer amortization table)
Bond=2131+2127=$ 4258
Note=2200+2144=$ 4344
Cash to be paid in year 3:		(Refer amortization table)
Bond=2250+2250=$ 4500
Note=3608+3608=$ 7216
Carrying value of note as on Dec 31,Year 5=$ 42026