On June 30 of the current year, Rural Gas & Electric Co. issued $50,000,000 face

Question

On June 30 of the current year, Rural Gas & Electric Co. issued $50,000,000 face value, 9 percent, 10-year bonds payable, with interest dates of December 31 and June 30. The bonds were issued at a discount, resulting in an effective semiannual interest rate of 5 percent

a compute the issue price for the ond that results in an effective semiaannual interest rate of 5%

b. prepare a journal entry to record the issuance of the bonds at the sales price you computed in part a

c. explain why the bonds were issued at a discount

I've have seen a few answers on here that are way off. Some using 50,000 instead of 50,000,000. If you could show how you get the answers that would be very helpful. Thank you.

Explanation / Answer

a compute the issue price for the Bond that results in an effective semiaannual interest rate of 5%

We have Par Value = FV = 50,000,000

No of period = nper = 10Yr*2 period/Tr = 20

Coupon = 9% Semi. So PMT = 9%*50,000,000/2 = 2250000

Effective Semi ANnual Int = Rate =5%

So Issue price = PV(Rate,nper,pmt,fv)

= PV(5%,20,2250000,50000000)

= $46,884,447.41

rounde off to $46,884,447

b. prepare a journal entry to record the issuance of the bonds at the sales price you computed in part a

30Jun Cash Dr $46,884,447

Discount on Bond Payable Dr $3,115,553

Bond Payable A/C Cr 50,000,000

c. explain why the bonds were issued at a discount

Bonds are issued at discount when its coupon yield is Less than the market yield. When its yield is Less than the market yield, the bond price will have to be sold at a discount to ensure the price is fair among all the securities traded after risk-adjusted and to avoid arbitrage opportunity.

In given case, we see that Coupon yield is 9% while Mkt yield is 5%*2=10%. Hence Bond is issued at Discount.

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