Problem Solving Survival Guide to accompany Financial Accounting, 8th Edition

SOLUTION TO EXERCISE D-2

Approach: The present value of the bond liability is determined by discounting all of the future cash flows related to the bond issue back to the present date using the current market rate of interest (6% per six-month interest period). The face amount of the bonds ($7,500,000) is a single amount due in 10 years (20 semiannual periods). The interest payments constitute an ordinary annuity for twenty semiannual periods. Each $300,000 interest payment is computed by multiplying the stated rate (4% per interest period) by the face amount of the bonds ($7,500,000).

TIP: The 8% stated rate must be expressed as 4% per six-month period before calculating the periodic $300,000 interest payment. Likewise, the 12% current market rate of interest (the effective rate) must be expressed on a per interest period basis (6%) before performing the present value computations.

TIP: The amount described as Principal is a future amount in this context; this is not to be confused with a situation where the term “principal” refers to a present value figure as was demonstrated early in this appendix.

TIP: The term principal, as it is used here, refers to the face value (face amount) of the bonds.