Imagination dragons corporation needs to raise funds to finance a plant expansion, and it has decided to issue 20-year zero coupon bonds with a par value of $1,000 each to raise the money. the required return on the bonds will be 7 percent. assume semiannual compounding periods. a. what will these bonds sell for at insurance? b. using the irs amortization rule, what interest deduction can the company take on these bonds in the first year? in the last year? c. repeat part (b) using the straight-line method for the interest deduction.(round your answers to 2 decimal places)

a. the price bonds sell for at insurance is $252.57

b. interest deduction can the company take on these bonds in the first year and last year under IRS amortization is $71.2 and 0 respectively

c. interest deduction can the company take on these bonds in the first year under straight-line method is $37.37

Explanation:

a. semiannual compounding periods for 20-year is 40

zero coupon rate then its future value is $1,000, thus the present value of this bond = $1,000/(1+7%/2)^40 = $252.57 or in excel = PV(3.5%,40,,1000)

b. The IRS requires that the constant yield method be used to amortize a bond premium every year. The constant yield method amortizes a bond premium by multiplying the adjusted basis by the yield at issuance and then subtracting the coupon interest.

Accrual = Purchase Basis x (Yield To Maturity /Accrual periods per year) – Coupon Interest

in which YTM  =-1

= (1000/252.57)^(1/20)-1 = 7.12%

Accrual for 1st year = (1000*(7.12%/2)-0)*2 = $71.2

which this IRS amortization, the company will fully deduct interest expense in  16 year = NPER(3.56%,35.6,747.43)

c. under straight-line method, the interest deduction the company can take in the first year and last year are same = ($1,000-$252.57)/20 = $37.37

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