Question

In: Finance

14) In order to accurately assess the capital structure of a firm, it is necessary to...

14) In order to accurately assess the capital structure of a firm, it is necessary to convert its balance sheet figures from historical book values to market values. KJM Corporation's balance sheet (book values) as of today is as follows: Long-term debt (bonds, at par) $23,500,000 Preferred stock 2,000,000 Common stock ($10 par) 10,000,000 Retained earnings 4,000,000 Total debt and equity $39,500,000 The bonds have a 7.0% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 11%, so the bonds now sell below par. What is the current market value of the firm's debt? A. $ 7,706,000 B. $17,436,237 C. $18,330,403 D. $17,883,320 E. $ 7,898,650

Solutions

Expert Solution

Step-1, The Price of the Bond

  • The Price of the Bond is the Present Value of the Coupon Payments plus the Present Value of the Face Value/Par Value.
  • The Price of the Bond is normally calculated either by using EXCEL Functions or by using Financial Calculator.
  • Here, the calculation of the Bond Price using financial calculator is as follows

Variables

Financial Calculator Keys

Figures

Par Value/Face Value of the Bond [$1,000]

FV

1,000

Coupon Amount [$1,000 x 7.00% x ½]

PMT

35

Market Interest Rate or Yield to maturity on the Bond [11.00% x ½]

1/Y

5.50

Maturity Period/Time to Maturity [10 Years x 2]

N

20

Bond Price/Current market price of the Bond

PV

?

Here, we need to set the above key variables into the financial calculator to find out the Price of the Bond. After entering the above keys in the financial calculator, we get the Price of the Bond (PV) = $760.9924.

Step-2, The current market value of the firm's debt

The current market value of the firm's debt = Number of Bonds outstanding x Price per Bond

= 23,500 Bonds x $760.9924 per Bond

= $17,883,320

“Hence, the current market value of the firm's debt will be $17,883,320”


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