Question

Real World Financials

Johnson & Johnson is one of the world’s largest manufacturers of health care products. The company’s July 2, 2017, financial statements included the following information in the long-term debt disclosure note:

	($ in millions)
	July 2, 2017
Zero-coupon convertible subordinated debentures, due 2020	$	69

The bonds were issued at the beginning of 2000. The disclosure note stated that the effective interest rate for these bonds is 3% annually. Some of the original convertible bonds have been converted into Johnson & Johnson shares of stock. The $69 million is the present value of the bonds not converted and thus reported in the financial statements. Each individual bond has a maturity value (face amount) of $1,000. The maturity value indicates the amount that Johnson & Johnson will pay bondholders at the beginning of 2020. Zero-coupon bonds pay no cash interest during the term to maturity. The company is “accreting” (gradually increasing) the issue price to maturity value using the bonds’ effective interest rate computed on a semiannual basis. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1)

Required:
1. Determine to the nearest million dollars the maturity value of the zero-coupon bonds that Johnson & Johnson will pay bondholders at the beginning of 2020. (Enter your answer in millions. Round your answer to nearest whole dollar amount.)

2. Determine to the nearest dollar the issue price at the beginning of 2000 of a single, $1,000 maturity-value bond. (Round your interest rate to the nearest whole dollar amount)

Answer 1

1:

The maturity value (face amount) can be determined by dividing the present value by the present value of $1 factor for 5 semiannual periods (middle of 2017 – beginning of 2020) at the semiannual rate of 1.5%:

PV of $1 factor = $ 69 ÷ 0.92826= $74

  

Present value of $1: n = 5, i = 1.5% (from Table 2)

So, $74 million is the maturity value (face amount) to be paid in 2.5 years. Of that amount, $74 – $69 = $5 million will represent interest at 1.5% for 5 semiannual periods.

2:

Using a 1.5% effective semiannual rate and 40 periods:

PV = $1,000 (0.55126) = $551.26

Present value of $1: n = 40, i = 1.5% (from Table 2)

The issue price of one, $1,000 maturity-value bond was $551.