The total cost of borrowing is increased only if the
A) bonds were issued at a premium.
B) bonds were issued at a discount.
C) bonds were sold at face value.
D) market interest rate is less than the contractual interest rate on that date.

Question

Quizplus · Accepted Answer

The total cost of borrowing is increased when the bonds are issued at a discount, since the discount is amortized over the life of the bond and increases the effective interest rate paid by the borrower. If the bonds are issued at a premium, the effective interest rate is reduced after taking into account the amortization of the premium. If the bonds are sold at face value, there is no premium or discount and the effective interest rate equals the contractual interest rate. If the market interest rate is less than the contractual interest rate, the borrower benefits since they are able to borrow at a lower rate than they initially agreed to. Therefore, the correct choice is B. If bonds were issued at a discount, the total cost of borrowing is increased because the company received less cash upfront but still needs to pay the full face value of the bond at maturity. This results in a higher effective interest rate than the stated contractual interest rate.

The Total Cost of Borrowing Is Increased Only If the