Question

Shanken Corp. issued a 25-year, 5.5 percent semiannual bond 4 years ago. The bond currently sells for 106 percent of its face value. The book value of the debt issue is $50 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 14 years left to maturity; the book value of this issue is $45 million and the bonds sell for 50 percent of par. The company’s tax rate is 25 percent.

a.	What is the company's total book value of debt? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
b.	What is the company's total market value of debt? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
c.	What is your best estimate of the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

A)Book Value of Debt = 50 Mn + 45 Mn = 95 Mn $

B)Market Value of Debt of first debt = 50 Mn*106% = 530,00,000 $

Market Value of Second Debt = 45 Mn * 50% = 225,00,000 $

Total market value of the Debt = 53 Mn + 22.5 Mn = 755,00,000 $

C)After-Tax Cost of debt :

YTM of first Debt : Interest Amount + ((Market value - Book Value)/Numbers of years to maturity)) / ((Mareket Value+Book Value)/2)

Substituting the above value = YTM of first debt = 5.03%

YTM of zero-coupon Bond = Yield To Maturity=(Face Value/Current Bond Price)^(1/Years To Maturity)−1

Substituting the above value = YTM of first debt = 5.08%

Weighted Average YTM = 5.03%*(53 Mn/75.5 Mn) + 5.08%(22.5 Mn/75.5 Mn) = 3.53 + 1.51 = 5.04%

Best estimate of after tax cost of debt = 5.04%(1-25%) = 3.78%