Question

Legacy issues $640,000 of 8.5%, four-year bonds dated january 1, 2017, that pay interest semiannually on june 30 and december 31. they are issued at $570,443 and their market rate is 12% at the issue date. 2. determine the total bond interest expense to be recognized over the bonds' life.

Answer 1

Answer : The total bond interest expense to be recognised over the bond's life is $217,600.

We arrive at the answer as follows:

$Total Bond Interest = Face Value of the bond * interest rate * no. of years$

In the question above, the face value of the bond is $640,000. We do not consider the issue price of the bond while computing interest on the bond.

The coupon rate on the bond is 8.5%.

The bond is a four-year bond.

Substituting these values in the equation above we get,

$Total bond interest = 640000 * 0.085 * 4$

$Total bond interest = 217600$

The issue price of the bond depends on prevailing market rates (12%). Since the market interest rate is greater than the coupon rate, investors will not invest in the bond unless they also receive a return of at least 12%. So, the bond is sold at a price lesser than face value - $570,443, in order to make the bond issue attractive to the investors.

These market values are not used while computing the total interest expense on the bond.