### CFA Practice Question

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### 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 CFO at the end of the first year?
A. Increase by 51,543
B. Decrease by 51,543
C. Decrease by 488,681
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 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). Thus, CFO would be reduced by 51,543.

User Comment
danlan The value of bond increases and CFO will be reduced.
danlan It's the bond price change from year 0 to year 1.
danlan Since interest expense > coupon, CFO decreases.
CoffeeGirl cause bond interest expense > coupon payment (CFO outflow)
Analyst must deduct the difference from CFO

so, if bond interest expenses < coupon payment (bond at premium ) analyst must add the difference to CFO
- This bond is issued at discount, it is value should be \$24,511,316.
- Interest payment is 4.5%*\$25,000,000 = \$1,125,000.
- Interest expense reported on Income statement using the "effective interest rate method is \$1,176,543.
- Diff. between \$1,176,543 - \$1,125,000 = \$51,543 is the amortized value of the bond.
- since this bond is issued at discount, it is amortized value "non-cash" should be added back to net income to reconcile of CFO.

So I belive the answer should be an increase of \$51,543.