Question

1. On January 1, Year 1, McTavish Incorporated issued bonds with a face value of $500,000, a stated rate of interest of 8%, and a 5-year term to maturity. The effective rate of interest was 10%. Interest is payable in cash on June 30 and December 31 of each year. Which of the following statements is true?
   1. This bond was issued at a premium, and each semiannual cash payment is $25,000.
   2. This bond was issued at a discount, and each semiannual cash payment is $20,000.
   3. This bond was issued at a discount, and the annual interest expense is $40,000.
   4. This bond was issued at a premium, and the annual interest expense is $40,000.

Answer 1

Stated interest rate = 8%

Effective interest rate = 10%

Since effective interest rate is more than stated interest rate, hence bonds will be issued at discount.

Par value of bonds = $500,000

Semi annual interest payment = Par value of bonds x Stated interest rate x 6/12

= 500,000 x 8% x 6/12

= $20,000

This bond was issued at a discount, and each semiannual cash payment is $20,000.

Correct option is b.

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