2. Chico Co. sold $4 million of 10-year bonds on December 31, 2015, with interest payable June 30 and December 31 at an annual rate of 12%. The bonds were priced to yield an effective rate of 10%.

The requirement of the question is provided below:

a.  What were the proceeds received by Chico upon the sale of the bonds?  

b.  Prepare the entry made by Chico to record the sale of the bonds on December 31, 2015.

The proceeds from the issue is $4,498,488.41

The entries are:

Dr Cash                     $4,498,488.41

Cr Bonds payable                              $4,000,000

Cr Premium on bonds payable           $498,488.41

Explanation:

The first task here is to determine the proceeds from the issue, which can be done using the present value formula in excel.

=pv(rate,nper,pmt,fv)

rate is the effective rate of 10% divided by 2,since coupon is paid twice a year.

nper is the time to maturity of 10 years multiplied by 2

pmt is the coupon payment paid twice a year, that is :12%/2*$4000,000=$240,000

fv is the value expected by investors upon redemption that is $4 million

=-pv(5%,20,240000,4000000)

pv=$4,498,488.41

a.

Proceeds from the Bond $44,984,884

b.

Journal Entry on Sale

Dr. Cash                         $44,984,884

Cr. Premium on Bonds  $4,984,884

Cr. Bond Payable           $40,000,000

Explanation:

The Bond was issued on the market value of the bond at the time of issuance. Price of the bond is the present value of all cash flows of the bond. These cash flows include the coupon payment and the maturity payment of the bond.

According to given data

Face value of the bond is $40,000,000

Coupon payment = C = $40,000,000 x 12% = $4,800,000 annually = $2,400,000 semiannually

Number of periods = n = 10 years x 2 = 20 period

Market Rate = 10% annually = 5% semiannually

Price of the bond is calculated by following formula:

Price of the Bond = C x [ ( 1 - ( 1 + r )^-n ) / r ] + [ F / ( 1 + r )^n ]

Price of the Bond = $2,400,000 x [ ( 1 - ( 1 + 5% )^-20 ) / 5% ] + [ 40,000,000 / ( 1 + 5% )^20 ]

Price of the Bond = 29,909,304.82 + 15,075,579.31 = $44,984,884.13

The Bond Was issued at $44,984,884

Premium ob the Bond = $44,984,884 - $40,000,000 = $4,984,884

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