Financial Accounting

Seminar - Corporate Bonds

Ale ornani
IES FSV, UK

Content
Recap Bonds
Case Study - Lyons Document Storage Corporation

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Recap (1) Bond

Bond is long-term liability (external source of cash)

Face value represents the principal.

Issue price Market Price is the bonds present value, which
equals the present value of the principal payment plus the present value of
the cash interest payments.

Interest rate
coupon rate determines coupon payments, set by the management
effective rate rate that investors require to be willing to buy and hold
the bond

Premium, Par, Discount

Pissue > Pface ~ reffect < rcoupon issue at premium
Pissue = Pface ~ reffect = rcoupon issue at par
Pissue < Pface ~ reffect > rcoupon issue at discount
-3-

Recap (2) - Coupon vs Interest expense

Interest payment (Coupon payment)
interest payment (coupon payment) is set by the
bond contract
Interest expense
interest expense represents effective costs.
IE = coupon payments +/() amortization of discount
(premium).
Methods of amortization
effective interest rate method
straightline method
-4-

Recap questions
The carrying value of Bonds Payable equals
a) Bonds Payable Premium on Bonds Payable.
b) Bonds Payable Discount on Bonds Payable.
c) Bonds Payable + Discount on Bonds Payable.
d) Bonds Payable + Accrued Interest.
The discount on a bond payable becomes
a) additional interest expense the year the bonds are sold.
b) additional interest expense over the life of the bonds.
c) a reduction in interest expense the year the bonds mature.
d) a reduction in interest expense over the life of the bonds.
e) a liability in the year the bonds are sold.
-5-

Problem 8.1
Bond data
Issue date January 1, 2008

Maturity date January 1, 2013

Face (par) value - $ 100,000

Market interest rate 10 % p.a.

Coupon interest rate 9 % p.a.

Issue price Streight

$96,149 line
method

Semi-annual Compounding

Complete the following amortization table using straight line method

for period 2008 - 2013
Date

-6-

Interest
payment

Interest
Expense

Amortization

Bond carrying amount

Problem 8.2
Bond data
Issue date January 1, 2008

Maturity date January 1, 2013

Face (par) value - $ 100,000

Market interest rate 10 % p.a.

Coupon interest rate 9 % p.a.

Issue price Streight

$96,149 line
method

Semi-annual Compounding

Complete the following amortization table using effective-interest

method for period 2008 - 2013
Date

-7-

Interest
payment

Interest
Expense

Amortization

Bond carrying amount

Case study
Lyons Document Storage Corporation
Rene Cook has just been given the assignment to analyze the
possible refunding of bonds in 2009 previously issued in 1999
when interest rates were much higher.
Because market interest rates had fallen between the time of
bonds were issued (1999) and 2009, refunding of the bonds
will necessitate recognition of a significant loss. On the other
hand, interest payments on new 2009 bonds would be much
lower in all subsequent periods.

-8-

Case study - Bonds

Bonds A old
20-year bonds issued on July 2, 1999
The face value of Bonds A is $10 million
Coupon rate of 8% with interest paid semi-annually, and
sold to yield the 9% market rate of interest at the time.

Bonds B new

-9-

10-year bonds will issued on January 2, 2009

The face value of Bonds B will be $10 million
Coupon rate of 6% with interest paid semi-annually
Bonds B could be issued to provide the company with
exactly $10 million, not considering underwriting costs

Case study - Assignment(1)

Lyons Document Storages controller, Eric Petro, told Rene
that the bonds were issued in 1999 at a discount and that only
approximately $9.1 million was received in cash.

- 10 -

1.

Explain what is meant by the terms premium or discount as

they relate to bonds.

2.

Compute exactly how much the company received from its 8%

bonds (bond A) if the rate prevailing at the time of the original
issue was 9%.

3.

Re-compute the amounts shown in the balance sheet at December

31, 2006, and December 31, 2007, for Long-Term Debt.

4.

What is the current market value (December 2008) of the bonds

outstanding at the current effective interest rate of 6% (Bond A)?

Case study - Solution(1)

Explain what is meant by the terms premium or discount as they
relate to bonds.
Bond A : Pface = $10,000,000 and Pissue $9,100,000
Pissue < Pface => issued at a discount
reffect > rcoupon ~ 9 % > 8 % => issued at a discount
Compute exactly how much the company received from its 8% bonds (bond A)
if the rate prevailing at the time of the original issue was 9%.

Pissue = PV(Bonds, rcoupon = 8%, reffect = 9%)

=
- 11 -

,,
,, %
+
=
= (+.%)
(+.%)

$9,079,921

Case study - Solution(1)

Re-compute the amounts shown in the balance sheet at December 31,
2006, and December 31, 2007, for Long-Term Debt.

000 USD
Long-term debt

at December 31,2006
$9,259

2006 =
=

2007 =
=

- 12 -

at December 31,2006
$9,292

, , % , ,
+
= $9,258,590

( + . %)
( + . %)
, , % , ,
+
= $9,292,611

( + . %)
( + . %)

Case study - Solution(1)

What is the current market value (December 2008) of the bonds
outstanding at the current effective interest rate of 6% (Bond A)?

2008 =
=

- 13 -

, , % , ,
+
= $11,541,503
( + %)
( + %)

Case study - Assignment(2)

2. If you were Rene Cook, would you recommend issuing $10
million, 6% bonds on January 2, 2009 and using the
proceeds and other cash to refund the existing $10 million,
8% bonds? Will it cost more, in terms of principal and
interest payments, to keep the existing bonds or to issue new
ones at a lower rate?
Be prepared to discuss the impact of a bond refunding on the
following areas:
cash flows
current years earnings
future years earnings

- 14 -

Case study - Solution(2)

Will it cost more, in terms of principal and interest payments, to keep the
existing bonds (Bond A) or to issue new ones at a lower rate (Bond B)?

Cost of Refunding Bonds A = the current market value of Bonds A

Cost of Refunding Old Bonds
$11,541,503
Proceeds from New Bonds
$10,000,000
Cash Cost of Refund the Bonds
$ 1,541,503
Savings from lower interest payment

- 15 -

, , % (, , , ) , ,
+
+
( + %)
( + %)
( + %)
= $1,541,503

For questions and additional information please

refer to the course website or the email:

ies.fin.acc@gmail.com

- 16 -

Recap (1)
Corporate bond is a long-term liability

Corporate bond represents a promise to pay:

- 17 -

interest/coupon payments

principal/face value/par value repayment(s)