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Chapter 9 Problem Session Exercise SOLUTION

Problem I: On 1/1/X1, Wolfpack Inc. issues 4%, 3-year bonds with a face value of $50,000. The market
interest rate for bonds of similar risk and maturity is 5%. Interest is paid semi-annually on June 30 and
December 31. The bonds mature on 12/31/X3.

A. What is the one-time cash outflow due to bondholders on 12/31/X3 when the bonds mature?

The face value of the bond is the one-time amount due at maturity.
Answer: $_50,000_

B. What is the semi-annual cash outflow due to bondholders on June 30 and December 31 of each year
beginning on 6/30/X1 and ending on 12/31/X3?

The semi-annual cash outflows are the cash interest payments. Cash interest payments are based on the
information found on the face of the bond. Face value x face rate x time.

$50,000 x 4% x 6/12 = $1,000
Answer: $_1,000

C. What is the present value of the one-time cash flow from A when the market rate of interest is 5%
compounded semi-annually. Round to the nearest whole dollar.

If interest is compounded semi-annually, there are a total of 6 compounding periods over the life of the
bonds at a rate of 2.5% per period.

PV = FV x PV Factor
n,r

PV = 50,000 x PV Factor
6, 2.5%

PV = 50,000 x .86230
PV = 43,115
Answer: $_43,115__

D. What is the present value of the semi-annual cash interest payments when the market rate of interest is
5% compounded semi-annually. Round to the nearest whole dollar.

Same n and i as above.

PVA = PMT x PVA Factor
n,r

PVA = 1,000 x PVA Factor
6, 2.5%

PVA = 1,000 x 5.50813
PVA = 5,508
Answer: $_5,508__

E. What is the issue price of the bonds on 1/1/X1? (hint: add together the answers for C and D)
43,115 + 5,508 = 48,623
Answer: $_48,623_
F. Were the bonds issued at face value, at a discount, or at a premium?

Answer: _discount__
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G. Using the bond issue price calculated in letter F, complete the following bond amortization schedule.
Round all amounts to the nearest whole dollar.

If necessary, adjust the final interest expense amount by $1 so that the carrying value exactly equals the
bonds face value at maturity.

Date Cash Payment


Interest Expense
(CV x market rate x time)
Amortization of
Discount
(Increase in CV)

Carrying Value (CV)

1/1/X1 $48,623
6/30/X1 $1,000 $1,216 $216 48,839
12/31/X1 1,000 1,221 221 49,060
6/30/X2 1,000 1,227 227 49,287
12/31/X2 1,000 1,232 232 49,519
6/30/X3 1,000 1,238 238 49,757
12/31/X3 1,000 1,243 243 50,000

Total $6,000 $7,377 $1,377


H. Using the amortization schedule for a bond issued at a discount, indicate whether each of the following
statements is true (T) or false (F):

True The carrying value on the issue date is equal to the bonds issue price.

True The carrying value of a bond issued at a discount increases over time.

True The carrying value on the maturity date is equal to the bonds face value.

True The cash interest payment stays the same over time.

True Interest expense for a bond issued at a discount increases over time.


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I. Prepare the journal entries for the dates noted below. Explanations are not needed.

Date Debit Credit

1/1/X1 Cash 48,623
Bond Payable 48,623

6/30/X1 Interest Expense 1,216
Cash 1,000
Bond Payable 216

12/31/X1 Interest Expense 1,221
Cash 1,000
Bond Payable 221

Problem II: The information below was found in Problem IV from the Appendix C problem session
exercise. You may want to briefly review that problem.

On 1/1/X4, Wolf Corp. purchased a warehouse facility costing $200,000. It made a $25,000 cash
down payment and financed the rest by signing a $175,000 note at 5% compounded annually for
30 years. The note will require a single payment at the end of each year beginning on 12/31/X4.

In the Appendix C problem session exercise, the annual loan payments were calculated to be $11,384. It was
also noted the highest interest cost would be incurred in year one because the loan balance at that time would
be highest.

Required: Complete the following partial amortization schedule for this note.

Date Cash Payment


Interest Expense
(CV x market rate x time)
Decrease in
Carrying Value

Carrying Value (CV)

1/1/X1 $175,000
1/1/X2 $11,384 $8,750 $2,634 172,366
1/1/X3 11,384 8,618 2,766 169,600
1/1/X4 11,384 8,480 2,904 166,696

Question: Although the loan payments stay the same, what do you notice about the way the loan payments
are apportioned between interest and principal as time goes by? Interest is calculated based on the loans
carrying value at the start of the period. Therefore, interest is highest in the first year of the loan and it
decreases thereafter. As the interest portion of the loan payment decreases, the principal portion increases.

Question: The rest of the amortization schedule does not need to be completed; however, if it were, what
should be the carrying value of the loan immediately after the last loan payment? It should be zero.