Question:
Clovis Company recently issued $500,000 (face value) bonds to finance a new construction project. The company’s chief accountant prepared the following bond amortization schedule:
Date Interest Expense Semiannual payment Premium Amortization Net Liability
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7/1/14 $540,554
12/31/14 $21,622 25,000 $(3,378) 537,176
6/30/15 21,487 25,000 (3,513) 533,663
12/31/15 21,347 25,000 (3,653) 530,010
6/30/16 21,200 25,000 (3,800) 526,210
12/31/16 20,048 25,000 (3,952) 522,258
6/30/17 20,890 25,000 (4,110) 518,148
12/3/17 20,726 25,000 (4,274) 513,874
6/30/18 20,555 25,000 (4,445) 509,429
12/31/18 20,377 25,000 (4,623) 504,806
6/30/19 20,197 25,000 (4,806) 500,000
Required:
1. Compute the discount or premium on the sale of the bonds, the semiannual coupon interest rate, and the semiannual effective interest rate.
2. The company’s vice president of finance wants any discount (or premium) at issuance of the bonds to be recorded immediately as a loss (or gain) at the issue date. Do you agree with this approach? Why or why not?
3. On December 31, 2016, the bonds’ net carrying value is $522,258. In present value terms, what does this amount represent?
4. Suppose that market interest rates were 6% semiannually on January 1, 2017, or 12.36% annually. [This 12.36% annual rate of interest is equal to the 6% semiannual rate, compounded: 0.1236 5 (1.06 3 1.06) 2 1.00.] What is the bond’s market price on that date? Is the company better or worse off because of the interest rate change? Explain