Question

On October 1, 2001, MarCo signs a one-year, 8% not payable for $10,000 with principle and interest due on October 1, 2012. It is MarCo's only not outstanding. On October 1, 2012 when the note is paid, MarCo debits Notes Payable and credits Cash for $10,800, the sum of principle and interest. This error is likely to be found because...

Answer 1

The present value of a two-year bond issued at $3,000 with an 8% interest rate is calculated by discounting the annual interest payments and principal at maturity. If discounted at 8%, the bond holds its par value; with an increase to an 11% discount rate, the bond's present value decreases.

Step-by-step explanation:

When assessing the value of a bond, the calculation of its present value takes into consideration the future stream of payments it will generate, discounted back to the present using a specific discount rate. For a simple two-year bond issued at $3,000 with an annual interest rate of 8%, the bond will pay $240 in interest each year ($3,000 × 0.08 = $240). We summarize the present value of the bond's cash flows with the formula:

Present Value of Annual Interests = Future annual interest payments / (1 + discount rate)^number of years.

Present Value of Principal at Maturity = Principal amount / (1 + discount rate)^number of years to maturity.

Using a discount rate of 8% and recalculating with an increased rate of 11%, the bond's present value changes:

Present Value at 8% discount rate: Interest payments and principal are discounted at the same rate as the bond's interest rate, which maintains the bond at its par value.

Present Value at 11% discount rate: When the discount rate increases, the present value of the bond's cash flows decreases, resulting in a lower present value for the bond compared to its face value.