Question

Jiminy’s Cricket Farm issued a 30-year, 6 percent semiannual bond three years ago. The bond currently sells for 93 percent of its face value. The book value of the debt issue is $95 million. In addition, the company has a second debt issue on the market, a zero coupon bond with eight years left to maturity; the book value of this issue is $40 million, and the bonds sell for 67 percent of par. The company’s tax rate is 22 percent.

a.	What is the company’s total book value of debt? (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? (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

1. Book Value of Debt = 95 million + 40 Million = 135
   
   b. Market Value of Debt = 93%*95+67%*40 = 115.15
   
   c. YTM of first bond is calculated as follows
   
   Let's assume par value of single bond = 1000
   Coupon= 6%*1000/2 = 30
   Price = 93%*1000 = 930
   Number of Periods = 27*2 = 54
   YTM using excel formula =2*RATE(54,30,-930,1000) = 6.56%
   
   
   Price of second bond = 67%*1000 = 670
   Number of periods = 8
   YTM of second bond = (1000/670)^1/8-1 = 5.13%
   Market value of debt of bond 1= 93%*95 = 88.35
   market value of zero coupon bond = 40*67% = 26.8
   
   
   Cost of debt = Cost of Debt * Weight of market value of debt + Cost of zero coupon debt* Weight of market value of zero coupon = 6.56%*88.35/115.15+5.13%*26,8/115.15 = 6.23%
   
   After tax cost of Debt = 6.074%*(1-Tax rate) = 6.23%*(1-22%) = 4.86%