Question

Adams Ltd is contemplating issuing ten-year $30,000 face value debentures, which, under present conditions, would yield an effective annual interest rate of 6%. The debentures would pay interest semi-annually at an annual interest rate of 4%.

1) Discuss how much cash Adams Ltd should receive on the date of issue, showing your calculations.

2) Is the annualized cost to Adams Ltd greater than, less than, or equal to the contract rate of 4%? Explain why.

Your answer should not exceed 50 words. Calculations can be in addition to these 50 words.

Format your answer by copying and pasting the following bold face into the answer box provided; however, please do not use bold face in your answer itself.

1) How much cash should Adams Ltd receive on the date of issue:

2) Is the annualized cost to Adams Ltd greater than, less than, or equal to the contract rate of 4%? Explain why.

Answer 1

1-	How much cash should Adams Ltd receive on the date of issue:			25536.48
	Value of bond	(coupon payment*PVAF At 2% for 20 semiannual period)+(face value*PVF at 2% at 20th semiannual period)	(600*14.8773)+(30000*.55367)	25536.48
	Coupon payment	30000*4%*1/2		600
	Face value			30000
	PVAF at 3% for 20 semi annual period	1-(1+r)^-n / r =1-(1.03)^-20 /3%	.44632/3%	14.87733333
	PVF at 3% at 20th semiannual period	1/(1+r)^n =1/(1.03)^20	1/(1.03)^20	0.553675754
2-	Annualized cost of debt (6%) is greater than the contract rate (4%) because bonds are issued at discount and are selling at a price lower than face value

Answer 2

Requirement 1:

Cash interest = $30,000 x 4% = $1,200

Present value of cash interest	$8,832
[$1,200 x 7.36009 PV annuity factor (6%, 10 years)]
Present value of face value	$16,752
[$30,000 x 0.55839 PV factor (6%, 10 years)]
Cash received on the date of issue	$25,584

Requirement 2:

Annualized cost to Adams Ltd is greater than the contract rate of 4%.

Say, Cash received is $25,584 and interest payment is $1,200. So, it is greater than the contract rate of 4%.

answered by: KEN