Question

Plesase show work (: On January 1, Bonita Industries issued $6900000, 9% bonds for $7348500. The market rate of interest for these bonds is 8%. Interest is payable annually on December 31. Bonita uses the effective-interest method of amortizing bond premium. At the end of the first year, Bonita should report unamortized bond premium of:

Answer 1

As per effective interest method,

amortized Bond premium=(Facevalue*coupon rate)-(present value of bond cashflows*market rate)

Given bond is perpetual bond. Hence unlimited cashflows

yearly interest=6900000*9%=621000

presentvalue of bond cashflows=621000+(621000/1.08)+(621000/1.08²⁾+(621000/1.08³⁾+.......

=621000[1+1/1.08+1/1.08²+1/1.08³+.......]

=621000{1+[1/1.08)/1-(1/1.08)]} {Geometric sum for an infinite series=a/(1-r)}

=621000(1+1/0.08)

=621000*(13.5)

=8383500

amortized bond premium for the year=facevalue*couponrate-pv of cashflows*marketrate

=(6900000*9%)-(8383500*8%)

=670680-621000

=49680

Total premium=7348500-6900000

=448500

Therefore,

unamortized Bond premium=total premium-amortized bond premium at the end of year

=448500-49680

=398820