Use the following information for questions 47-49.
On July 2, 2020, Martineau Ltd. issued $ 6,000,000 (par value), 9%, ten-year convertible bonds at 98. The bonds were dated April 1, 2020 with interest payable quarterly on July 1, October 1, January 1 and April 1. If the bonds had NOT been convertible, they would have sold for 96.1. The bond discount is amortized on a straight-line basis. On April 1, 2021, $ 1,200,000 of these bonds were converted into 500 no par common shares. Accrued interest was paid in cash at the time of conversion.
-What was the effective interest rate on the bonds when they were issued?
A) 9%
B) above 9%
C) below 9%
D) cannot determine from the information given

Question

Quizplus · Accepted Answer

The effective interest rate on the bonds when they were issued is higher than the stated coupon rate of 9% because the bonds were issued at a discount. To calculate the effective interest rate, we need to calculate the present value of the future cash flows using the issue price of 98 (98% of par value) and the market price of 96.1 if the bonds were not convertible. The effective interest rate is the rate that equates the present value of the future cash flows to the issue price. Using a financial calculator or spreadsheet, the effective interest rate is approximately 9.24%. Therefore, the best choice is B (above 9%).

Use the Following Information for Questions 47-49