Question

At the beginning of the year, Lambert Motors issued the three notes described below. Interest is paid at year-end. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1 ) (Use appropriate factor(s) from the tables provided.) 1. The company issued a two-year, 12%,$600,000 note in exchange for a tract of land. The current market rate of interest is 12%. 2. Lambert acquired some office equipment with a fair value of $94,643 by issuing a one-year, $100,000 note. The stated interest on the note is 6%. The current market rate of interest is 12%. 3. The company purchased a building by issuing a three-year installment note. The note is to be repaid in equal installments of $1 million per year beginning one year hence. The current market rate of interest is 12%. Required: Prepare the journal entries to record each of the three transactions and the interest expense at the end of the first year for each. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Do not round intermediate calculations. Enter your answers in whole dollars.)

Answer 1

The present value of bonds depends on the discount rate applied to their payment stream. Ford Motor Company's bond has a 3% interest rate. If market interest rates increase, existing bond values decrease.

Step-by-step explanation:

When evaluating bond valuations, such as those provided by Lambert Motors or Ford Motor Company, we consider the payment stream from the bond and apply a discount rate to determine present value. For example, a simple two-year bond issued at $3,000 with an 8% interest rate will yield annual interest payments of $240, plus the return of the principal at the end of the second year. To calculate the present value of this bond, we would use the present value interest factor (PVIF) which reflects the current market discount rate.

Calculation for the present value of the $3,000 bond at 8% discount rate is:

Year 1 Interest: $240 discounted at 8% for one year

Year 2 Interest + Principal: ($240 + $3,000) discounted at 8% for two years

If the discount rate increases to 11%, the present value will be recalculated using 11% as the discount rate, which will result in a lower present value, reflecting the higher opportunity cost of capital.

Ford Motor Company Bond Example

a. The interest rate paid by Ford on its bond can be found by dividing the annual coupon payment by the face value of the bond. Therefore, Ford's interest rate:

Interest Rate = $150 / $5,000 = 3%

b. If the market interest rate rises from 3% to 4%, the value of Ford's bond would decrease. The increase in market interest rates means new bonds are issued at higher rates, making existing bonds with lower rates less valuable.