Question

Enviro Company issues 8%, 10-year bonds with a par value of $250,000 and semiannual interest payments. On the issue date, the annual market rate for these bonds is 5%, which implies a selling price of 1233⁄8. The straight-line method is used to allocate interest expense.

1. What are the issuer’s cash proceeds from issuance of these bonds?

2. What total amount of bond interest expense will be recognized over the life of these bonds?

3. What is the amount of bond interest expense recorded on the first interest payment date?

Short answer

1. Cash proceeds from the issue of bonds are$308,438
2. The total bond interest expense is $141,562
3. The first interest expense is$7,078

Step-by-step solution

Meaning of Bonds

Bonds refer to security instruments issued by a company to raise public funds; in return, it guarantees to pay fixed interest installments.

Calculation of the issuer’s cash proceeds from the issuance of the bonds

Calculation of cash proceeds

$\begin{array}{rcl}\mathit{C}\mathit{a}\mathit{s}\mathit{h}\mathbf{ }\mathit{p}\mathit{r}\mathit{o}\mathit{c}\mathit{e}\mathit{e}\mathit{d}\mathit{s}\mathbf{ }\mathit{o}\mathit{n}\mathbf{ }\mathit{I}\mathit{s}\mathit{s}\mathit{u}\mathit{e}\mathbf{ }\mathit{o}\mathit{f}\mathbf{ }\mathit{b}\mathit{o}\mathit{n}\mathit{d}& \mathbf{=}& \mathbf{\$}\mathbf{250}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{123}\mathbf{.}\mathbf{375}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{308}\mathbf{,}\mathbf{438}\\ & & \end{array}$

Calculation of total bond interest expense

Interest computation
Twenty payments of $10,000 $\left[20 \text{payments}\times \left(\$250,000\times 8\%\times \frac{1}{2}\right)\right]$	$200,000
Less: Premium	58,438
Total bond interest expense	$141,562

Calculation of bond expense for the first year

$\begin{array}{rcl}\text{Bond} \text{interest} \text{expense}& =& \frac{\text{Total} \text{bond} \text{interest} \text{expense}}{\text{Number} \text{of} \text{interest} \text{periods}}\\ & =& \frac{\$141,562}{20}\\ & =& \$7,078\\ & & \end{array}$