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On 1 July 2014 Michaela Ltd issues $1 million in five-year debentures that pay interest each six months at a coupon rate of 10 per cent. At the time of issuing the securities, the market requires a rate of return of 8 per cent. Interest expense is determined using the effective-interest method.
REQUIRED
(a) Determine the issue price.
Answer:
In this question, the interest payments of 10% are made each 6 months for 5 years. Therefore, we will treat the debentures as offering a coupon rate of 5% over 10 periods. Similarly, the market rate will be calculated as 4% for 10 periods.
(a) The issue price is equal to the present value of the interest annuity and the principal repayment. The discount rate is the market's required rate of return: in this case, 4%.
Issue price:
PV of principal = 1 000 000 x 0.6755642 =
675 564
PV of annuity = 50 000 x 8.1108957 =
405 545
1 081 109
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