Question

Tesla Corporation needs to raise funds to finance a plant expansion, and it has decided to issue 30-year zero-coupon bonds to raise the money.

The required return on the bonds will be 9 percent.

a. What will these bonds sell for at issuance

b.  Using the IRS amortization rule, what interest deduction can the company take on these bonds in the first year? In the last year?

c. Interest deduction. Using the straight-line method, what interest deduction can the company take on these bonds in the first year? In the last year?.

d. Based on your answers in (b) and (c), which interest deduction method would Tesla Corporation adopt?

Answer 1

Answer is attached below

Answer a

FV of using 9% ordinary annuity for 30 periods = 13.26767846913125

Issue Price = $1,000 / 13.26767846913125 = $75.37

Answer b

First year = ($75.37 x 1.09) – 75.37 = $6.78

Last year = $1,000 - 1,000 / (1.09) = $82.57

Answer c

Total interest deduction = $1,000 – 75.37 = $924.63

Annual Interest deduction = $924.63 / 30 years = $30.82

Interest deduction:

First year = $30.82

Last year = $30.82

Answer d

IRS Amortization provides an increasing interest deduction throughout the life of a bond or until its maturity while on the other side, the straight-line method provides a fixed or the same interest deduction annually. Both the method will provide the same of the total interest deductions during whole life of the bonds. But the company should adopt the IRS amortizations since it complies with the matching principle of revenues and expenses.