Question:
On January 1, 2014, Nicks Corporation issued $250 million of floating-rate debt. The debt carries a contractual interest rate of “LIBOR plus 5.5%,” which is reset annually on January 1 of each year. The LIBOR rates on January 1, 2014, 2015, and 2016, were 6.5%, 7.0%, and 5.5%, respectively.
Required:
1. Prepare a journal entry to record the issuance of the bonds on January 1, 2014, at par. What was the effective (or market) interest rate when the bonds were issued?
2. Prepare a journal entry to record interest expense for 2014, 2015, and 2016. Assume that interest is paid annually on December 31.
3. What is the market value of the debt at December 31, 2016, assuming Nicks Corporation’s credit risk has not changed.