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Ellis is planning to issue $470,000 of 12%, ten-year bonds payable to borrow for a major expansion
Ellis is planning to issue $470,000 of 12%, ten-year bonds payable to borrow for a major expansion. The owner, Simon Ellis, asks your advice on some related matters. Read the requirements. Requirement 1. Answer the following questions. a. At what type of bond price will Ellis have total interest expense equal to the cash interest payments? Face value Premium price b. Under which type of bond price will Ellis's total interest expense be greater than the cash interest payments? c. If the market interest rate is 15%, what type of bond price can Ellis expect for the bonds? Requirement 2. Compute the price of the bonds if the bonds are issued at 91. The price of the $470,000 bond issued at 91 is $0. Requirement 3. How much will Ellis pay in interest each year? How much will Ellis's interest expense be for the first year? (Assume the straight-line method is used.) Ellis will pay sin interest each year. (Round your answers to the nearest whole dollar.) Assuming that the straight-line method is used, Ellis's interest expense will be [ for the first year.
Expert Solution
Important Notes:
->Assuming interest Compounded Annually, as it is not mentioned.
->Assuming Face Value of Each Bond is $100 (for Q2)
Q1) c) Given the current market rate of 15% for a similar bond, a bond with a face value of $470,000 and paying a coupon rate of 12% (compounding annually), should be selling for $399,235.36 (selling at a discount). Here is how I arrived at my answer: using PV Formula
| Variables |
| C = coupon payment = $56,400 (Par Value * Coupon Rate) |
| n = number of years = 10 |
| i = market rate, or required yield = 15% = 0.15 |
| k = number of coupon payments in 1 year = 1 |
| P = value at maturity, or par value = 470000 |
Q2) PV Price of $470,000 Face Value Bonds at $91 Each is = 399,235.36 * 91%
=
Note: Additionally we can also multiply Face Value and use ($470,000*91) and apply in PV Formula. Above is a shortcut method.
Q3) Coupon Payments = Interest Expense.
As it is already calculated when finding sellling price, we know it is (Par Value * Coupon Rate) = $470,000 * 12%
= $56,400
NOTE: The Interest Expense will be Standard for every year as Straight Line Method is being followed.
please see the attached file for the complet solution.
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