Quantitative Problem: Potter Industries has a bond issue outstanding with an annual coupon of 6% and a 10-year maturity. The par
value of the bond is $1,000. If the going annual interest rate is 7.8%, what is the value of the bond? Do not round intermediate calculations. Round your answer to the nearest cent.
1 answer:
Answer:
$878.12
Explanation:
Value of bond is calculated by discounting this value of its coupon payments by an appropriate discount rate. The discount rate used is the yield to maturity, which is that the rate of return that an investor will get if he or she reinvested every coupon payment from the bond at a fixed interest rate until the bond matures. It takes into consideration the worth of a bond, par value, coupon rate, and time to maturity.
Mathematically,
V coupons=∑ C/(1+r) t
CV face value= F/(1+r) T
where:
C=future cash flows, that is, coupon payments
r=discount rate, that is, yield to maturity
F=face value of the bond
t=number of periods
T=time to maturity
Find the attached sheet for solving.
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Answer:
The question has asked to first create the income statement with the gain/loss on sale of asset and then find for depreciation. However, in order to create the income statement, we require the gain/loss on sale of asset and to do this, we require the depreciation. Hence, the order has been slightly changed but titled easily for your convenience (1. Depreciation 2. Sale of Asset 3. Income statement. Please refer explanation.
Explanation:
1. DEPRECIATION
1.A. Straight-line depreciation:
It is the simplest method of calculating depreciation and believes that the asset's value depreciates equally every year.
Depreciation per year = (Cost of asset - salvage value) / number of useful life years.
Depreciation for Year 1 : (7000 - 500) / 5 = $1300
Depreciation for Year 2: (7000 - 500) / 5 = $1300
Depreciation for Year 3 : (7000 - 500) / 5 = $1300
1. B. Units of Production/ Activity based depreciation:
Activity based depreciation is whereby an asset is depreciated based on the asset’s activity such as the number of hours worked or the number of units produced, during a particular period of time. Activity based depreciation per year is calculated as:
[(Cost - Salvage value) x activity performed during the period] / Total estimated life activity of the asset
Year 1 Depreciation : (7000-500) x (3100 / 13000) = $1550
Year 2 Depreciation : (7000-500) x (2500 / 13000) = $1250
Year 3 Depreciation : (7000-500) x (3400 / 13000) = $1700
1.C. Double-declining balance Method:
This is where the asset's value is depreciated at twice the rate than the straight line method. The depreciation amounts would be higher in the early years of the asset's life and gradually reduce towards the end. Hence, it does not mean that the depreciation amount would be higher than the straight line basis.
Straight Line depreciation per year = 1/5* x 100 = 20%
*as it is useful for five years
Hence double-depreciation value = 20% x 2 = 40%
It is calculated as depreciation rate x book value of asset at the beginning of the period
OR (Cost of Asset - Accumulation Depreciation) x Depreciation rate
Depreciation for Year 1 : 7000 x 40% = $2800
Accumulated Depreciation : $2800
Depreciation for Year 2 : (7000 - 2800) x 40% = $1680
Accumulated Depreciation: $2800 + $1680 = $4480
Depreciation for Year 3 : (7000 - $4480) x 40% = $1008
2. GAIN OR LOSS ON SALE OF ASSET
2.A. Straight-line depreciation :
Accumulated Depreciation at the end of Year 3 : $1300 x 3 = $3900
Cost of asset at the end of Year : $7000 - $3900 = $3100
Asset was sold for $2100 while its net book value was $3100. This means that the asset was sold for LESS than what it was worth and hence is a LOSS on sale of asset.
Gain/Loss on sale of asset : Sale Price - Net book value
Loss on sale : $2100 - $3100= ($1000)
2.B. Units of Production method :
Accumulated depreciation at the end of the Year 3 : $1550 + $1250 + $1700 = $4100
Cost of asset at the end of Year 3 : $7000 - $4500 = $2500
Asset was sold for $2100 while its net book value was $2500. This means that the asset was sold for LESS than what it was worth and hence is a LOSS on sale of asset.
Gain/Loss on sale of asset : Sale Price - Net book value
Loss on sale : $2100 - $2500= ($400)
2.C. Reducing balance method :
Accumulated depreciation at the end of Year 3 : $2800 + $1680 + $1008 = $5488
Cost of asset at the end of Year 3 : $7000 - $5488 = $1512
Asset was sold for $2100 while its net book value was $1512. This means that the asset was sold for MORE than what it was worth and hence is a GAIN/PROFIT on sale of asset.
Gain/Loss on sale of asset : Sale Price - Net book value
Gain on sale : $2100 - $1512= $588
3. INCOME STATEMENT
Income statement with gain/loss on sale of asset using straight line depreciation, units of production method and reducing balance method has been provided in attached tables 1, 2 and 3 respectively.
