Page 601 - Accounting Principles (A Business Perspective)

15. Long-term financing: Bonds

An accounting perspective:

Business insight

Some persons estimate that Social Security will be broke by the year 2025 unless changes are
made. Therefore, you may want to set aside funds during your working career to provide for
retirement.
Over the last 60 years, the inflation rate has averaged about 3 per cent per year, treasury bills have
averaged a little under 4 per cent per year, corporate bonds have averaged about a little over 5 per
cent per year, and stocks have averaged a little over 10 per cent per year. Using the tables at the
end of the text we can determine how much you would have at age 65 if you invested USD 2,000

each year for 45 years in treasury bills, corporate bonds, or stocks, beginning at age 20.
To do this calculation for treasury bills, for instance, we would first use Table A.2 to determine the
future value of an annuity of USD 2,000 for 30 periods at 4 per cent (USD 2,000 X 56.08494 =
USD 112,170). (We would have used 45 periods, but the table only went up to 30 periods.) Then we
would use Table A.1 to find the value of this lump sum of USD 112,170 for another 15 years at 4 per
cent (USD 112,170 X 1.80094 = USD 202,011). Then we cannot forget that we have another 15
years of USD 2,000 annuity to consider. Thus, we go back to Table A.2 and calculate the future
value of an annuity of USD 2,000 for 15 periods at 4 per cent (USD 2,000 X 20.02359 = USD
40,047). Then we add the USD 202,011 and the USD 40,047 to get the total future value of USD

242,058. (You would have invested USD 2,000 X 45 years = USD 90,000.) Would you be pleased?
Not when you see what you could have had at age 65 if you invested in stocks.
If you had invested in corporate bonds at 5 per cent, you would have USD 319,401. However, if you
had invested in stocks at 10 per cent, you would have USD 1,437,810 at age 65. Can you use the
tables in the back of the text to verify these amounts?

Bonds issued at a discount Assume the USD 100,000, 12 per cent Carr bonds are sold to yield a current
market rate of 14% annual interest, or 7 per cent per semiannual period. Carr computes the present value (selling
price) of the bonds as follows:

Cash X Present =Present value
flow value factor
Principal of $100,000 due in six interest periods multiplied by
present value factor for 7% from Table A.3 of the Appendix $100,00 X0.66634 =$66,634
(end of text) 0
Interest of $6,000 due at the end of six interest periods
multiplied by present 6,000 X4.76654 =28,559
value factor for 7% from Table A.4 of the Appendix (end of
text)
Total price (present value) $95,233
Note that in computing the present value of the bonds, Carr uses the actual USD 6,000 cash interest payment

that will be made each period. The amount of cash the company pays as interest does not depend on the market
interest rate. However, the market rate per semiannual period—7 per cent—does change, and Carr uses this new
rate to find interest factors in the tables.

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