CFA Practice Question

There are 1201 practice questions for this topic.

CFA Practice Question

Laker Corporation issued $250,000 in 20-year bonds payable, with 6% interest payable annually. At the time of the bond issuance, the market rate for similar quality investments was 5%. Present value factors are:

PVIF of $1, 20 periods, 5%, .37689
PVIF of $1, 20 periods, 6%, .31180
PVIF of Annuity of $1, 20 periods, 5%, 12.46221
PVIF of Annuity of $1, 20 periods, 6%, 11.46992

Laker's entry to record the sale is:

A. Cash (debit): 218,844
Bond discount (debit): 31,156
Bonds payable (credit): 250,000

B. Cash (debit): 281,156
Bond premium (credit): 31,156
Bonds payable (credit): 250,000

C. Cash (debit): 250,000
Bond premium (debit): 31,156
Bonds payable (credit): 281,156

D. Cash (debit): 281,156
Bond discount (credit): 31,156
Bonds payable (credit): 250,000
Correct Answer: B

Cash received is ($ 250,000 x .37689) + ($ 15,000 x 12.46221), or $281,156, which is greater than the bonds' face amount. The premium is $31,156 ($281,156 - $250,000). The 5% effective rate is used to compute cash received; the 6% coupon rate is used to compute the annual interest payment.

User Contributed Comments 17

User Comment
intj The key answer says 6% rate is used to compute the annual interest payment, but the computation uses the 5% figure for annuity. So which one is correct?
fuller 6% is used to compute the actual interest payment, which includes both annuity (interest expense) and premium. The answer is correct.
kalps NB. 250,000 20-yr bonds payable means 20 years maturity with payment of 250,000 in 20 years time. Assuming that they are redeemed at PAR
tinku Fuller: In your explanation you said you are computing the interest payment based on 6%coupon rate. But your computation shows you are using annuity factor corresponding to 5%. Which one is correct?
jwp2 Tinku: Interest is paid annually at the stated coupn rate--6%. The market price, and thus the proceeds, are determined by the prevailing rate at the time of issuance--5%
Will1868 Think of it from an imvestment/fixed income perspective. The cash flows yearly are the I-PMT (6% coupon) - these are discounted at the prevailing market rate (5%). There is also the final cash flow of $250K (par) to retire the bonds. So if you sum the NPV of all future cash flows (using 5% as the discount) you get 281,156 (very easy with an HP by the way.
haarlemmer In the exam, I will just look at the rates. As in this case, market rate is lower than the company rate, therefore, it must be sold at higher than face value and at a premium. Under this, answer could only be B.
yanpz Based on Notes, should the answer be D? Credit to Bond Discount Payable?
wollogo Answer is not D, the bond is issued at a premium not a discount. 281,156 > 250,000
uberstyle did we truly need the PVIF information? When I value a bond with 6% coupons at 5%, I get the same PV. Anything wrong with this approach in general?
StanleyMo hello uber, is that your PMT stick to "market rate" amount?
arkot90 in fact we dont have to compute sth as B is the only correct answer in terms of accounting for premium bonds.
kutta2102 No calculations are required in this one - method of elimination works well. Here's how: the bond has to sell for a premium since the interest rate offered is better than the market rate. That leaves B&D as the only options. Then, one has to decide how the bond premium should be recorded in the ledger - the bond is sold at a premium and D uses an account called bond discount, which doesn't make sense. Therefore, B is the only choice left.
YOUCANDOIT Thx kutta2102
thekobe you dont need to make calculations, just take a look at the cash, it should be more than 250,000 since the mkt rate is less than the interest rate. So you only have B or D, but again mkt rate is less than the interest rate, so its a bond sold at a premium
Freddie33 Does nobody else not get what any of the numbers mean for the PV factors?
walterli Entry must have a balance,so ...
You need to log in first to add your comment.