The following example illustrates how the prices of $100,000 of bonds issued by Big Dog Carworks Corp. were derived. Recall the three scenarios:
- Big Dog Carworks Corp. issues $100,000 of 3-year, 12% bonds on January 1, 2015 when the market rate of interest is also 12%. Interest is paid semi-annually.
- BDCC’s bonds are issued at a premium ($110,485) because the market rate of interest is 8% at the date of issue for similar bonds offered in the market.
- BDCC’s bonds are issued at a discount ($90,574). The market rate of interest is 16%.
There are two steps to calculate the present value of the bonds, because there are two types of future cash amounts that relate to the bond issue. The bond principal will be repaid at the end of three years, and interest payments will be received every six months for three years. The present value of each of these must be calculated and totalled to arrive at the present value of the bonds at the date of issue.
In the examples below, it will be shown that the resulting amount equals the issue price of the bonds in each scenario described above. First, the present value of the repayment of the bond principal at the end of three years for each of the three scenarios will be calculated.
- 935 reads
