Question

plum corporation issues 200,00 of 5 percent

9. Plum Corporation issues $200,000 of 5 percent, five-year bonds on January 1, 20x5, at 90. The market interest rate is 6%. The bond indenture states that interest is to be paid on January 1 and July 1 of each year. Using effective interest method, what is the interest expense on July 1, 20x5? (Please show your computation in the blank space between #9 and #10 before you select the answer choice)

Answer 1

Since market interest rate (6%) is higher than coupon rate (5%), the bond is issued at discount.

Amount of discount = Par value – Issue price

                                    = 200,000 – [200,000 × (90/100)]

                                    = 200,000 – 180,000

                                    = 20,000

Cash payment for interest in each semi-annual period = Par value × Coupon rate × ½

                                                                                          = 200,000 × 5% × ½

                                                                                          = 5,000

Interest expense (1^st July, 20X5) = (Par value – Discount) × Market rate × ½

                                                       = (200,000 – 20,000) × 6% × ½

                                                       = 180,000 × 6% × ½

                                                       = 5,400 (Answer)