Question

Long-Term Debt – Bonds

Paddington Company sold $10,000,000 worth of bonds on January 1, 2015. The bonds were 10-year bonds with a 5% coupon paid annually. The market rate of interest was 4 percent.

A) How much did the company receive from issuing the bonds on January 1, 2015? Were the bonds sold at a premium or discount?

B) What was the interest expense reported on the income statement from these bonds in the first 2 years?

C) This question is independent of you answers for A and B above. Paddington sold a bond at par on January 1, 2012. The bond currently sells for 110% of the bonds initial face value in the secondary bond market. Assuming that the default risk of Paddington has not changed, what does the current price tell you about how interest rates have changed from when the bonds were issued? Would Paddington record a gain or loss if they were to buy back the bond at the current price? Answer conceptually but explain your logic.

Answer 1

Table values are based on:
n=	10
i=	4.0%
Cash Flow	Table Value	Amount	Present Value
Interest	8.11090	$5,00,000	$40,55,450
Principal	0.67556	$1,00,00,000	$67,55,600
Price of Bonds			$1,08,11,050
Premium on Bond =$10,811,050 - $10,000,000 =$811,050
Amortization table-When the Bond is issued at premium
	Col I	Col II	Col III	Col IV
Date	Interest Payment($10,000,000*5%)	Interest expenses(Col IV*4%)	Premium amorrtization(Col I -Col II)	Bond carrying amount
01-Jan-15				1,08,11,050
31-Dec-15	5,00,000	4,32,442	67,558	1,07,43,492
31-Dec-16	5,00,000	4,29,740	70,260	1,06,73,232
So Interest expenses for Year 1 is $432,442
So Interest expenses for Year 2 is $429,740