Question

Shanken Corp. issued a 25-year, 4.3 percent semiannual bond 4 years ago. The bond currently sells for 90 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 52 percent of par. The company’s tax rate is 23 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 million + 45 Million = 95

b. Market Value of Debt = 90%*50+52%*45 = 68.4

c. YTM of first bond is calculated as follows

Let's assume par value of single bond = 1000
Coupon= 4.3%*1000/2 = 21.50
Price = 90%*1000 = 900
Number of Periods = 25*2 = 50
YTM using excel formula =2*RATE(50,21.50,-900,1000) = 5%


Price of second bond = 52%*1000 = 520
Number of periods = 14
YTM of second bond = (1000/520)^1/14-1 = 4.78%

Cost of debt = Cost of Debt * Weight of market value of debt + Cost of zero coupon debt* Weight of market value of zero coupon = 5%*45/68.4+4.78%*23.4/68.4 = 4.93%

After tax cost of Debt = 4.93%*(1-Tax rate) = 4.93%*(1-23%) = 3.79%