Practice Problems: Bonds

Complete the demo problem, and self test true/false and multiple choice questions. Check your answers at the end after you finish.

Self-test

Answers

True-false

1. True. These unsecured bonds are called debenture bonds and are backed only by the general creditworthiness of the issuer.

2. False. Callable bonds may be called at the option of the issuer.

3. True. This statement is the definition of favorable financial leverage. However, unfavorable financial leverage can result when favorable financial leverage was planned. Unfavorable financial leverage will result if income before interest and taxes is much lower than anticipated. Then earnings per share for the common stockholders would be lower than they would have been without the borrowing.

4. True. Purchasers will not be willing to pay the face amount if the market rate of interest exceeds the contract rate. By paying less than the face value, purchasers can earn the market rate of interest on the bonds.

5. False. The effective interest rate method is the recommended method. The straight-line method may be used only when the results are not materially different from the interest method.


Multiple-choice

1. a. The discount of USD 4,000 must be recorded. Also, the accrued interest must be recognized (USD 100,000 X 12 percent X 2/12 = USD 2,000).

2. c. The premium is USD 4,000, and the accrued interest is USD 2,000. Both must be recognized.

3. b. The interest is (USD 328,298 X 0.11 X 1/2 ) = USD 18,056.

4. d. The interest would have been (USD 400,000 X 0.04) + (USD 71,702/20) = USD 19,585.

5. c. Income before interest and taxes is (USD 100,000 + USD 40,000 + USD 20,000) = USD 160,000. This total of USD 160,000 divided by interest of USD 20,000 = 8 times.