(CMA adapted, Dec 90 #12) Marla, Inc.issued $6,000,000 of 12% bonds on December 1, Year 1, due on December 1, Year 6, with interest payable each December 1 and June 1.The bonds sold for $5,194,770 to yield 16%.If the discount is amortized by the effective interest method, Marla, Inc.'s interest expense for the fiscal year ended November 30, Year 2 related to its $6,000,000 bond issue will be

Question

Quizplus · Accepted Answer

The first step is to calculate the total interest expense over the life of the bond, which is ($6,000,000 x 0.12) = $720,000 per year.

Next, we need to calculate the amount of discount amortized each year. We can use the effective interest method to allocate the discount proportionally over the life of the bond.

The effective interest rate can be calculated as follows:

PV = $5,194,770
FV = $6,000,000
N = 5 years
PMT = $360,000 (semi-annual interest payments)

Using these inputs, we can use a financial calculator or Excel to solve for the rate. The effective interest rate is approximately 8.5%.

We can then calculate the amount of discount amortization for Year 2:

Discount amortization = Beginning Discount Balance x Effective Interest Rate 
= ($6,000,000 - $5,194,770) x 8.5% 
= $640,073

Finally, we can calculate the interest expense for Year 2 as follows:

Interest Expense = Total Interest Expense - Discount Amortization 
= $720,000 - $640,073 
= $79,927 (for one semi-annual interest payment) 
= $79,927 x 2 
= $159,854 (for the entire year)

Therefore, the correct answer is C) $835,610.

(CMA Adapted, Dec 90 #12) Marla, Inc