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Problem 12-19 Calculating Capital Structure Weights [LO 3] Liu Industrial Machines issued 147,000 zero coupon bonds...

Problem 12-19 Calculating Capital Structure Weights [LO 3]

Liu Industrial Machines issued 147,000 zero coupon bonds four years ago. The bonds originally had 30 years to maturity with a yield to maturity of 7.2 percent. Interest rates have recently increased, and the bonds now have a yield to maturity of 8.3 percent.

If the company has a $46.2 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., 32.1616.)
  
Weight of debt            

Solutions

Expert Solution

Weight of debt is 0.2858

Step-1:Calculation of current market value of bond (debt)
Market value of bond is the present value of cash flows from bond.
A zero coupon bond does not pay any coupon interest.So, present value of cash flows from bond is the present value of its face value.
Price of zero coupon bond = Face value * Present value of 1 to be received at the end of year 26
= $                   1,000 * 0.125794058
= $                 125.79
Working;
Present value of 1 to be received at the end of year 26 = (1+i)^-n Where,
= (1+0.0830)^-26 i 8.30%
= 0.125794058 n 26
Step-2:Calculation of weight of debt
Weight of debt = Market Value of debt / Market value of total capital
= $       1,84,91,727 / $ 6,46,91,727
= 0.2858
Working:
Market Value of debt = Total number of bonds * Current market price of a bond
=                  1,47,000 * $           125.79
= $       1,84,91,727
Market Value of Equity = $       4,62,00,000
Market Value of debt = $       1,84,91,727
Market Value of capital $       6,46,91,727

jeff jeffy answered 2 years ago
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