Weather Corp. issued ten-year, 8%, $100,000 bonds paying interest on an annual b

Question

Weather Corp. issued ten-year, 8%, $100,000 bonds paying interest on an annual basis, at a $5,200 premium. Which one of the following statements is true? a. Weather's annual interest expense on the bonds will be less than the amount of interest payments to bondholders each year. b. Weather will receive $94,800 as the issue price. c. The cash paid to bondholders will be $520 each interest period. d. Weather's annual interest expense on the bonds will be greater than the amount of interest payments to bondholders each year.

Explanation / Answer

The statement a) is true. Weather's annual interest expense on the bonds will be less than the amount of interest payments to bondholders each year. This is so because the bonds are issued at a premium of $5,200 which will be written off over the life of bonds equally (i.e.$5,200/10 years = $520)

The interest payment sto bondholders annually = Face value*Interest rate = $100,000*8% = $8,000

Effective interest expense for the year = $8,000 - $520 = $7,480

Therefore the annual interest expense of $7,480 will be less than annual interest payments of $8,000.

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