Question

Suspect Corp. issued a bond with a maturity of 25 years and a semiannual coupon rate of 8 percent 3 years ago. The bond currently sells for 93 percent of its face value. The book value of the debt issue is $45 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 13 years left to maturity; the book value of this issue is $45 million and the bonds sell for 53 percent of par. The company’s tax rate is 35 percent.

1.the company’s total book value of debt?

2. What is the company’s total market value of debt

3. What is your best estimate of the aftertax cost of debt

Answer 1

1 Book value of Debt = $ 45 million + $ 45 million = $ 90 million

2 Market Value of Debt1= 45x93% = $ 41.85 million

Market Value of Debt2+ 45x53% = $ 23.85 million

Market Value of Total Debt = $ 65.7 million

3 Calculating after tax cost of Debt1:

market price = $ 93

coupon per semiannual = 4

No of half-years remaining = 44 (22 years)

Therefore, Yield on Debt = 4.36% per half year

Effective Yield on Debt = (1.0436)² - 1 = 8.91% p.a.

After Tax cost of Debt1 = 8.91% (1-35%) = 5.79% p.a.

Calculating after tax cost of Debt2:

Effective Annual cost of Debt = (100/53)^(1/13) - 1 = 5.00 % p.a.

Effective Annual after-tax cost of Debt = 5.00% (1-35%) = 3.25%

Average aftertax cost of Debt = (41.85 x 5.79% + 23.85 x 3.25%) / (65.70) = 4.87% p.a.

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