Question

Adonis Corporation issued 10-year, 7% bonds with a par value of $250,000. Interest is paid semiannually. The market rate on the issue date was 6%. Adonis received $268,603 in cash proceeds. Which of the following statements is true?

A.) Adidas must pay $268,603 at maturity plus 20 interest payments of $8,750 each.
B.) Adidas must pay $268,603 at maturity and no interest payments.
C.) Adidas must pay $250,000 at maturity plus 20 interest payments of $7,500 each.
D.) Adidas must pay $250,000 at maturity and no interest payments.
E.) Adidas must pay $250,000 at maturity plus 20 interest payments of $8,750 each.

Answer 1

Answer: The correct answer is C.) Adidas must pay $250,000 at maturity plus 20 interest payments of $7,500 each.

Step-by-step explanation:

The cash proceeds of $268,603 represent the present value of the bond. The bond's par value is $250,000, which is the amount Adonis Corporation will pay at maturity. The 7% coupon rate is applied to the par value of the bond, so the annual interest payment is $17,500 ($250,000 x 7%). Since the bond pays interest semiannually, each interest payment will be $8,750 ($17,500 ÷ 2).

The market rate on the issue date was 6%, which is less than the bond's coupon rate of 7%. This means the bond is issued at a premium, which is why the cash proceeds are higher than the par value of the bond.

At maturity, Adonis Corporation will pay back the par value of the bond, which is $250,000. In addition, it will make 20 interest payments of $8,750 each, for a total of $175,000 ($8,750 x 20). Therefore, the total amount Adonis Corporation will pay over the life of the bond is $425,000 ($250,000 + $175,000).