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Chapter 12: 5RQ (page 654)
What is the difference betwee the stated interest rate and the market interest rate?
The stated and market interest rates are different in many ways. Both play a vitol role in the bond market.
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On December 31, 2018, when the market interest rate is 8%, Arnold Corporation issues $200,000 of 6%, 10 year-bonds payable. The bonds pay interest semiannually. Determine the present value of the bonds at issuance.
Determining bond prices
Bond prices depend on the market rate of interest, stated rate of interest, and time.
Determine whether the following bonds payable will be issued at face value, at a
premium, or at a discount:
a. The market interest rate is 8%. Idaho issues bonds payable with a stated rate
of 7.75%.
b. Austin issued 9% bonds payable when the market interest rate was 8.25%.
c. Cleveland’s Cars issued 10% bonds when the market interest rate was 10%.
d. Atlanta’s Tourism issued bonds payable that pay the stated interest rate of 8.5%. At
issuance, the market interest rate was 10.25%.
How does compound interest differ from simple interest?
Determining bond prices and interest expense
Jones Company is planning to issue $490,000 of 9%, five-year bonds payable to
borrow for a major expansion. The owner, Shane Jones, asks your advice on some
related matters.
Requirements
1. Answer the following questions:
a. At what type of bond price Jones Company will have total interest expense
equal to the cash interest payments?
b. Under which type of bond price will Jones Company’s total interest expense be
greater than the cash interest payments?
c. If the market interest rate is 12%, what type of bond price can Jones Company
expect for the bonds?
2. Compute the price of the bonds if the bonds are issued at 89.
3. How much will Jones Company pay in interest each year? How much will Jones
Company’s interest expense be for the first year?
Accounting for a long-term note payable
On January 1, 2018, Lakeman-Fay signed a \(1,500,000, 15-year, 7% note. The loan
required Lakeman-Fay to make annual payments on December 31 of \)100,000
principal plus interest.
Requirements
1. Journalize the issuance of the note on January 1, 2018.
2. Journalize the first note payment on December 31, 2018.
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