Dektronik Corporation manufactures electrical test equipment. The company's board of directors authorized a bond issue on January 1,2010, with the following terms:

Maturity (par) value: \(\$ 800,000\)

Interest: 7.5 percent per annum payable each December 31 Maturity date: December 31,2014 Effective interest rate when sold: 8 percent

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1. Compute the bond issue price. Explain why both the stated and effective interest rates are used in this computation.

2. Assume that the company used the straight-line method to amortize the discount or premium on the bond issue. Compute the following amounts for each year (2010-2014):

a. Cash payment for bond interest.

b. Amortization of bond discount or premium.

c. Bond interest expense.

d. Carrying amount of the bond.

e. Interest expense as a percentage of carrying amount (item \([c] \div\) item \([d]\) ).

The straight-line method is theoretically deficient when interest expense is related to the carrying amount of the debt. Explain.

3. Assume instead that the company used the effective interest method to amortize the discount or premium. Prepare an effective interest bond amortization schedule similar to the one in the text (see p. 587). The cffective interest method provides a constant interest rate when interest expense is related to the carrying amount (unpaid balance). Explain by referring to the bond amortization schedule.

4. Which method should the company use to amortize the bond discount or premium? As a financial analyst, would you prefer one method over the other? If so, why?