Question

1. On January 1, Princeton, Inc. issued $2 million of 8% bonds at 93.5% of par, based on an effective rate of 9%. The bonds pay interest on June 30 and December 31. Using the effective interest rate method, Princeton’s bond liability immediately after the first coupon payment is made is closest to:

	$1,870,000.
	$1,874,150.

$2,000,000.

2. On January 1, Princeton, Inc. issued $2 million of 8% bonds at 93.5% of par, based on an effective rate of 9%. The bonds pay interest on June 30 and December 31. Princeton’s total interest expense over the 10 year term of the bonds is closest to:

	$1,600,000.
	$1,683,000.

$1,730,000.

Answer 1

Answer to Question 1:

Face Value of Bonds = $2,000,000

Annual Coupon Rate = 8.00%
Semiannual Coupon Rate = 4.00%
Semiannual Coupon = 4.00% * $2,000,000
Semiannual Coupon = $80,000

Issue Value of Bonds = 93.50% * $2,000,000
Issue Value of Bonds = $1,870,000

Annual Interest Rate = 9.00%
Semiannual Interest Rate = 4.50%

First Coupon Payment:

Interest Expense = 4.50% * $1,870,000
Interest Expense = $84,150

Amortization of Discount = Interest Expense - Coupon Paid
Amortization of Discount = $84,150 - $80,000
Amortization of Discount = $4,150

Carrying Value = Issue Value of Bonds + Amortization of Discount
Carrying Value = $1,870,000 + $4,150
Carrying Value = $1,874,150

Answer to Question 2:

Total Amount Paid = Total Coupon Payments + Maturity Payment
Total Amount Paid = 20 * $80,000 + $2,000,000
Total Amount Paid = $3,600,000

Total Interest Expense = Total Amount Paid - Issue Value of Bonds
Total Interest Expense = $3,600,000 - $1,870,000
Total Interest Expense = $1,730,000