Question

The following questions are not related.

Requirements

1. Duncan Brooks needs to borrow \(500,000 to open new stores. Brooks can borrow \)500,000 by issuing 5%, 10-year bonds at 96. How much will Brooks actually receive in cash under this arrangement? How much must Brooks pay back at maturity? How will Brooks account for the difference between the cash received on the issue date and the amount paid back?

2. Brooks prefers to borrow for longer periods when interest rates are low and for shorter periods when interest rates are high. Why is this a good business strategy?

Short answer

The given bonds are issued at a discount and the amount received on the issue is $480,000.

Step-by-step solution

Definition of bonds

The bond is a long-term debt that is issued by the company to fulfill a large number of cash needs.

Cash received on the issue of bonds

$\begin{array}{c}\text{Cash\hspace{0.17em}\hspace{0.17em}Received\hspace{0.17em}=\hspace{0.17em}\hspace{0.17em}Face\hspace{0.17em}\hspace{0.17em}Value\hspace{0.17em}\hspace{0.17em}of\hspace{0.17em}the\hspace{0.17em}\hspace{0.17em}Bonds×\hspace{0.17em}Issue\hspace{0.17em}\hspace{0.17em}price}\\ \text{=\hspace{0.17em}\$500,000×\hspace{0.17em}96}\\ \text{=\hspace{0.17em}\$480,000}\end{array}$

At the maturity of the bonds, Brooks needs to pay $500,000.

The difference between the cash received on the issue and the amount paid back is known as the discount this amount is amortized with payment of the interest.

Business strategy 

This is a good business strategy because the long-term bonds have a low-interest expense on the other hand if he borrows for short periods then the interest expense is more. Hence, borrowing for long periods is a good business strategy.