CFA Practice Question

There are 520 practice questions for this study session.

CFA Practice Question

Jorgensen Products has just issued 25,000,000 in 4.50% annual coupon bonds at a market yield of 4.80%. The bonds have a maturity of 8 years. What adjustments would an analyst make to the CFF at the end of the first year?
A. Decrease by 51,543
B. Decrease by 488,681
C. Increase by 51,543
Explanation: Proceeds of bond issue: PMT = 1,125,000; I/Y = 4.80; FV = 25,000,000; N = 8; CPT PV = 24,511,316

Jorgensen will recognize this as a liability. Its annual interest will be, interest = 0.048 x 24,511,316 = 1,176,543

Jorgensen records a CFO of -1,125,000 based on the coupon payment. The analyst would reduce the CFO by 51,543 to reflect the higher interest cost (= 1,176,543 - 1,125,000).

The CFF would have to be increased by the same amount, 51,543, to reflect the fact that this differential interest is owed and will be paid at maturity. Thus, CFF will have to be increased by 51,543.

User Contributed Comments 11

User Comment
danlan CFF increased = CFO decreased.
danlan When issued at discount, CFF increases (bond value will increase and close to pay) and CFO decreases (coupon > interest expense)
danlan Use Amort, set P1=P2=1
Rivermax Work out present value of bonds,
PV X implied interest rate
Calculate difference between implied payment and actual coupon payment.
xanados The key concept is that a portion of the coupon payment is essentially going to pay down the principal, and that amount should be counted as CFF.
xanados Sorry, more info on last comment. When the coupon is higher than the interest rate, part of the coupon is paying down the principal, in essence, so it should be counted as a outflow in CFF. In this case the coupon doesn't cover the full interest charge, so the CFF should be increased, as it's like amortized additional borrowing (inflow).
robbruhr thanks xanados gr8 descrip.
teje for discount bonds, CFO is overstated because of the lower coupon payment vs. the actual interest expense incurred. This means that CFF is understated.

We need to decrease CFO by the discount amortization (which is the difference between interest expense - coupon payment) and add this amount to CFF

Remember at maturity of the bond the outflow from financing will be the higher par value (i.e. face value)
oneashok great question... and grt explanation by users..
Lambo83 $51543 is correct but if it is an outflow then CFF should decrease not increase.
MonuPanda i still don't get it. In the text it is written that bond amortisation of discount bond should be added to net income to get CFO.. Here the difference 51543 should be added to CFO.
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