Question

Jiminy's Cricket Farm issued a 30-year, 6.3 percent semiannual bond eight years ago. The bond currently sells for 110 percent of its face value. The book value of the debt issue is $135 million. In addition, the company has a second debt issue, a zero coupon bond with 12 years left to maturity; the book value of this issue is $65 million, and it sells for 64.3 percent of par. The company’s tax rate is 22 percent.

a.	What is the total book value of debt?

b.	What is the total market value of debt?

C. What is the aftertax cost of debt?

Round to 3rd decimal place.

Answer 1

a

BV of Bond1=Par value*bonds outstanding*%age of par

BV of Bond1=1000*135000*1

=135000000

BV of Bond2=Par value*bonds outstanding*%age of par

BV of Bond2=1000*65000*1

=65000000

BV of firm debt = MV of Bond1+ MV of Bond 2

=135000000+65000000

=200000000

b

MV of Bond1=Par value*bonds outstanding*%age of par

MV of Bond1=1000*135000*1.1

=148500000

MV of Bond2=Par value*bonds outstanding*%age of par

MV of Bond2=1000*65000*0.643

=41795000

MV of firm debt = MV of Bond1+ MV of Bond 2

=148500000+41795000

=190295000

c

Cost of debt

Bond1

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =22x2

1100 =∑ [(6.3*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^22x2

k=1

YTM1 = 5.5100746126

Bond2

K = Nx2

Bond Price   =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =12x2

643 =∑ [(0*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^12x2

k=1

YTM2 = 3.71

Firm cost of debt=YTM1*(MV bond1)/(MV bond1+MV bond2)+YTM2*(MV bond2)/(MV bond1+MV bond2)

Firm cost of debt=5.5100746126*(148500000)/(148500000+41795000)+3.71*(148500000)/(148500000+41795000)

Firm cost of debt=5.11%

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 5.11*(1-0.22)

= 3.986