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 would 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?

Please show all work

Answer 1

1 Cash paid under the two schemes

Bonds = 50 bonds * 1000 each = 50000

Coupon rate = 9% semi annual

Hence the cash in Year 1 = 50000*1.045*1.045 = 54601.25 - 50000 = 4601.25

Notes = 50000

Rate is 8% semi annual

Cash at Year 1 = 50000*1.04*1.04 = 54080 - 50000 = 4080

2. Interest expense in year 2

Bonds = 54601*1.045*1.045 = 59625.65 - 54601 = 5024.40

Notes = 54080*1.04*1.04 = 58493 - 54080 = 4413

3 The pay out for the bond issue in Year 3 would be 50000* (1.045)⁶ = 65113 (approx)

4 The amount of cash for the long term notes payable in Year 3 would be 50000* (1.04)⁶ = 63265 (approx)

5 The carrying amount of the loan payable in the Year 5 would be

{50000* (1.04)⁸ }-50000 = 68428-50000 = 18428

Hence carrying amount will be 50000-18428 = 31572