Question

Ace Industrial Machines issued 144,000 zero coupon bonds five years ago. The bonds have a par value of $1,000 and originally had 30 years to maturity with a yield to maturity of 7.4 percent. Interest rates have recently increased, and the bonds now have a yield to maturity of 8.5 percent.

What is the dollar price of the bonds? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

What is the market value of the company's debt? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

If the company has a $45.9 million market value of equity, what weight should it use for debt when calculating the cost of capital? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., .1616.)

Answer 1

Solution

Price of zero coupon bond today=Par value/(1+r)^n

Where

r=rate of discounting=YTM=8.5%

n=number of periods=25

1. Price of zero coupon bond today=1000/(1+.085)^25=130.09

2. Market value of company's debt=Price of zero coupon bond today*number of bonds

=144000*130.09

=18732960.00

3. Value of equity=45.9 million=45900000

Value of debt=18732960.00

Total value of firm=Value of equity+Value of debt=45900000+18732960.00

=64632960

Weight to be used for debt in WACC=Value of debt/Total value of firm=18732960/64632960

=0.2898

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