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On 1 July 2018 Power Ltd
On 1 July 2018 Power Ltd. issues $10 million in five-year debentures that pay interest each six months at a coupon rate of 5 per cent. At the time of issuing the securities, the market requires a rate of return of 8 per cent. Interest expense is determined using the effective-interest method.
Required:
- Determine if the debenture is issued premium or discount? (2 marks)
- Determine the Fair Value of the Debentures? (3 marks)
Expert Solution
1). Since, the fair value is less than the face value so the debenture is issued at a discount.
2). We can calculate the fair value by using the following formula in excel:-
=-pv(rate,nper,pmt,fv)
Here,
PV = Fair value of the bond
Rate = 8%/2 = 4% (semiannual)
Nper = 5*2 = 10 periods (semiannual)
Pmt = Coupon payment = $10,000,000*5%/2 = $250,000
FV = $10,000,000
Substituting the values in formula:
= -pv(4%,10,250000,10000000)
= $8,783,365.63
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