Q21E_2 - Horngren'S Financial And Managerial Accounting

Question

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?

Step-by-Step Solution

Answer

The price of the bonds is $436,100

Step 1: Definition of the bond face value

Face value of the bond is the stated amount of the bond on which interest rate is calculated on regular basis.

Step 2: Calculation of the price of bonds

In the given question, bonds are issued at 89, which means the bonds are issued at a discount.

$\begin{array}{rcl}Bond Price& =& Face Value\times Issue Rate\\ & =& \$490,000\times 89\%\\ & =& \$436,100\end{array}$