Question

On January 1, of the current year, Colour Inc. issued bonds with a face value of $500,000. The bonds pay interest annually and mature in 10 years. The bonds have a stated interest rate of 6%. The market rate on the date of issue was 4%.

1. Compute the issue price of the bonds

2. What will the carrying value of the bond be at maturity?

3. What will be the total amount of interest expense recognized over the life of the bonds? (Note- you do not need to do an amortization schedule to answer this question.)

Answer 1

Answer 1.

Face Value of Bonds = $500,000

Annual Coupon Rate = 6%
Annual Coupon = 6% * $500,000
Annual Coupon = $30,000

Time to Maturity = 10 years
Annual Interest Rate = 4%

Issue Price of Bonds = $30,000 * PVIFA(4%, 10) + $500,000 * PVIF(4%, 10)
Issue Price of Bonds = $30,000 * (1 - (1/1.04)^10) / 0.04 + $500,000 / 1.04^10
Issue Price of Bonds = $581,109

Answer 2.

Carrying value of the bonds at maturity will be $500,000

Answer 3.

Total Amount paid = 10 * $30,000 + $500,000
Total Amount paid = $800,000

Total Interest paid = Total Amount paid - Amount borrowed
Total Interest paid = $800,000 - $581,109
Total Interest paid = $218,891