Question

Knot Corp., issued 10 -year, 8%$100,000 bonds paying interest on an annual basis, at a $5,200 premium. Which one of the following statements is true? A. Knot's annual interest expense on the bonds will be greater than the amount of interest payments to the bondholders each year. B. Knot's annual interest expense on the bonds will be less than the amount of interest payments to the bondholders each year. C. Knot will receive $94,800 as the selling price. D. The cash paid to the bondholders will be $520 each interest period. E. The amount of interest expense each year will increase over the life of the bond.

Answer 1

The correct answer to the question is B. Knot's annual interest expense on the bonds will be less than the amount of interest payments to the bondholders each year.

To understand why, let's break down the information given:

1. The bonds have a 10-year maturity period and a face value of $100,000.
2. The bonds pay an annual interest rate of 8%.
3. The bonds were issued at a $5,200 premium.

The premium indicates that the bonds were sold for more than their face value. So, Knot received $100,000 (face value) + $5,200 (premium) = $105,200 from the sale.

Now, let's calculate the annual interest expense and interest payments:

1. Annual interest expense: $105,200 (selling price) x 8% (interest rate) = $8,416.
2. Interest payments to bondholders each year: $100,000 (face value) x 8% (interest rate) = $8,000.

As you can see, the annual interest expense ($8,416) is greater than the interest payments to bondholders each year ($8,000). Therefore, the correct answer is B. Knot's annual interest expense on the bonds will be less than the amount of interest payments to the bondholders each year.

In summary, despite issuing the bonds at a premium, Knot's annual interest expense is still less than the amount of interest payments made to bondholders each year.