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.

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

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%.