Accounting practices for interest expenditures may neither reflect actual economic cost nor mirror those for interest revenues.A town plans to borrow about $10 million and is considering three alternatives. A town official request your guidance on the economic cost of each of the arrangements, and your opinion as to how they affect the town's reported expenditures:
Alternative 1: The town would issue $10 million of 20-year, 6% coupon bonds on September 1, 2013. The bonds would be issued at par. A town would be required to make it first interest payment of $300,000 on January 1, 2014.
Alternative 2: The town would issue $10 million of 20-year, 6% bonds on July 1, 2013. The bonds would be sold for $9,552,293, a price that reflects an annual yield (effective interest rate) of 6.4%. The town would be required to make its first interest payment of $300,000 on December 31, 2013.
Alternative 3: The town would issue $32,071,355 in 20-year zero coupon bonds on July 1, 2013. The bonds would be sold for $10 million, an amount that reflects an annual yield of 6%. The bonds require no payment of principal or interest until June 30, 2032.
1. For each of the town's three alternatives, what would be the town's economic cost of using the funds in the year ending December 31, 2013. What would be the amount of interest expenditure that the town would be required to report in its governmental funds for the year ending December 31, 2013.