Comprehensive-Bond-Problem

PartA

Thebonds were issued at discounts. In valuation of bonds, we look at theselling price and compare it with the face value of that bond. Theselling is determined by getting the present value of the same bond(Arnold,2008).A bond has got two types of amounts that needs to be discounted. Thatis, the single amount or the principal which is paid at the end ofperiod or the maturity date and the annuities which are the interestspaid periodically.

Bondscan be issued at par, at discount or at premium. Bonds are said to beissued at par if their selling price is equal to their face value, atdiscount if selling price is less than the face value and at premiumif the selling price is greater than the face value (Arnold,2008).To determine whether the bonds at Victory Falls Company were issuedat par, at discount or at premiums, we can start by getting theselling price or the present value of the bond as shown in part Bbelow.

PartB

Discountingboth the principal and the annuities quarterly

PV=FV (1+r)^{-n} where, r=Discounting rate = Market rate = (6/4)% =0.015

Andn = 5 × 4 = 20 periods

PV= $2100000(PVIF_{1.5%20})

PV= $2100000 × 0.74247 = $1559187.88

Forthe annuities

Interestrate= 8% /4 =2%

Annuity=2%*2100000= $42,000

PVIFA2%20=__1-(1+r)__^{-n}=17.168639

r

PV=Annuities × PVIFA2%20 = 42000 × 17.1686 = $721082.82

Thereforethe selling price, SP of the bond = present value of the principleplus the present value of the annuities.

SP= 1559187.88 + 721082.82 = *$2280270.71*

Therefore,the issue price of the bonds on January 1, 2014 was $2280270.71

Thisprice is higher than the face value of the bonds and therefore thebonds were issued at premiums.

*Journalentries*

*1*^{st}*Jan 2014 $ $*

Cash 2280270

Premiumson bond 180270

Bondspayable 2100000

PartC

Atstraight line bases the interest rate is 8% per annum.

Ateffective interest rate, the EIR can be calculated as follows

EIR=*100% *100= 1.84188 quarterly = 7.3675% per annum.

Seethe excel spreadsheets for the amortization tables

PartD

*Journalentries to record the interest expense (at straight line bases) *

*30*^{th}*June 2014 $ $*

Interestexpense 34087

Premiumson bond 7913

Cash 42000

*31*^{st}*Dec2014 $ $*

Interestexpense 33848

Premiumson bond 8152

Cash 42000

Note:The figures are as shown in the amortization schedule as per the dateindicated.

Thesejournal entries show the balances to be shown in the income statementof the company. The amount is an expense to the company and hence itreduces the net profit.

PartE

Ateffective interest rate, the market rate changes from 6% to 7.3675%per annum.

*Journalentries to record the interest expense (at effective interest rate)*

*30*^{th}*June 2014 $ $*

Interestexpense 39652

Premiumson bond 2348

Cash 42000

*31*^{st}*Dec2014 $ $*

Interestexpense 39565

Premiumson bond 2435

Cash 42000

PartF

Usingthe straight line bases, the book value of the bonds as at:

30^{th}June 2014 is $2,264,561

31^{st}Dec2014 is $2,248,377

Thebook value is the remaining balance on the bond. In this case ofVictory Falls Company, the book values can be gotten from theamortization table. These value is shown in the statement offinancial position as a long term liability. It is a long termliability since the bonds have a maturity duration of 5 years andhence it is a long term obligation to the company.

PartG

Usingthe effective-interest rate method, the book value of the bonds asat:

30^{th}June 2014 is $2,150,481

31^{st}Dec2014 is $2,145,655 (from the amortization schedule)

Similarlythis values will also appear in the statement financial position aslong term liabilities.

PartH

Byretiring the bond on 30^{th}June 2015, Victory Falls Company will have utilized the bond for 1.5years. This means that the company will have to pay the full amountof the net book value of the bond plus the 1% of one- time payment.

Thejournal entries will look as follows

Straightline method-

*30*^{th}*June 2015 $ $*

Interestexpense 33601

Premiumson bond 8399

Cash 42000

Uponretirement of the bond, the journal entries will be as follows

Totalpayments= $2231704+ (2231704*1%)= $2254021

*30*^{th}*June 2014 $ $*

Premiumson bond 48565

Bondspayable 2100000

P&Laccount 405456

Cash __ __ __2254021__

__2254021__ __2254021__

*Usingthe effective interest rate-*

*30*^{th}*June 2015 $ $*

Interestexpense 39474

Premiumson bond 2526

Cash 42000

Uponretirement of the bonds

Totalpayments= $2231704+ (2140650*1%) = $2,162,056

*30*^{th}*June 2014 $ $*

Premiumson bond 14483

Bondspayable 2100000

P&Laccount 47573

Cash __ __ __2162056__

__2162056__ __2162056__

References

ArnoldG. (2008).*Corporate financial management 4*^{th}*edition*.Britain: Pearson Education.

Kiesos.(2014). *howbond market pricing woks*.Retrieved March 25, 2015, from Investopedia:

http://www.investopedia.com/articles/bonds/07/pricing_conventions.asp

EugeneB. & Michael E.(2008). *FinancialManagement: Theory & Practice *Branzil:Amazon.