dotamasta

draz Wrote:
-------------------------------------------------------
> Can anyone explain the logic here:
>
> Acme Corp. wants to issue debt with proceeds net
> of issuance costs of $75 million. Acme reports
> under U.S. GAAP. Acme’s investment banker
> estimates that issuance costs and market yield
> will both be the same whether Acme issues premium
> or discount bonds to raise the $75 million. If
> Acme chooses to issue the premium bonds rather
> than the discount bonds, it will report:
>
> A) lower net income during the bonds’
> life.
> B) higher interest expense during the bonds’
> life.
> C) lower operating cash flow during the bonds’
> life.
>
> They say that the higher cupons increase cash
> interest costs=>lower CFO (which I agree).
> What I don't understand is why B is not correct as
> well....In other words, what's the difference
> between the cupon payments and the interest
> expense?
>
> Thx


Say you issue a 10 year annual coupon bond for $100. Coupon - 10%
If market rate is 11% - Discount bond. Proceeds = 94
Market rate is 9% - Premium bond. Proceeds = 106
Coupon Payment in either case = $10 (10% of 100)
Interest Expense in Discount bond = 11% of 94 = $10.34 (Higher than coupon)
Interest Expense in Premium bond = 9% of 106 = $9.54 (Lower than coupon)