Scan Soft Development Company is developing a new process to manufacture optical disks. The development costs were higher than expected, so Scan Soft required an immediate cash inflow of $5 200 000. To raise the required capital, the company decided to issue bonds. Since Scan Soft had no expertise in issuing and selling bonds, the company decided to work with an investment dealer. The investment dealer bought the company’s entire bond issue at a discount, and then sold the bonds to the public at face value or the current market value. To ensure it would raise the $5 200 000 it required, Scan Soft issued 5400 bonds with a face value of $1000 each on January 20, 2012. Interest is paid semi-annually on July 20 and January 20, beginning July 20, 2012. The bonds pay interest at 5.5% compounded semi-annually.
Scan Soft directors realize that when the bonds mature on January 20, 2032, there must be $5 200 000 available to repay the bondholders. To have enough money on hand to meet this obligation, the directors set up a sinking fund using a specially designated savings account. The company earns interest of 1.6% compounded semi-annually on this sinking fund account. The directors began making semi-annual payments to the sinking fund on July 20, 2012.
Scan Soft Development Company issued the bonds, sold them all to the investment dealer, and used the money raised to continue its research and development.
QUESTIONS
1. How much would an investor have to pay for one of these bonds to earn 4.4% compounded semi-annually?
2. (a) What is the size of the sinking fund payment?
(b) What will be the total amount deposited into the sinking fund account?
(c) How much of the sinking fund will be interest?
3. Suppose Scan Soft discovers on January 20, 2022, that it can earn 2.5% interest compounded semi-annually on its sinking fund account.
(a) What is the balance in the sinking fund after the January 20, 2022, sinking fund payment?
(b) What is the new sinking fund payment if the fund begins to earn 2.5% on January 21, 2022?
(c) What will be the total amount deposited into the sinking fund account over the life of the bonds?
(d) How much of the sinking fund will then be interest?