Question

In: Finance

Jiminy's Cricket Farm issued a 30-year, 8 percent semi-annual bond 7 years ago. The bond currently...

Jiminy's Cricket Farm issued a 30-year, 8 percent semi-annual bond 7 years ago. The bond currently sells for 87 percent of its face value. The book value of the debt issue is $25 million. The company's tax rate is 34 percent.

In addition, the company has a second debt issue on the market, a zero coupon bond with 7 years left to maturity; the book value of this issue is $77 million and the bonds sell for 74 percent of par.

   

Required:

   

(a) What is the company's total book value of debt? (Do not round your intermediate calculations.)
(Click to select)102,000,000130,850,000130,080,00073,150,00078,730,000

  

(b)

What is the company's total market value of debt? (Do not round your intermediate calculations.)

(Click to select)78,730,00081,879,20074,793,50082,666,500102,000,000

  

(c)

What is your best estimate of the aftertax cost of debt? (Do not round your intermediate calculations.)

(Click to select)4.29%3.6%4.08%3.79%2.87%

Solutions

Expert Solution

1st Issue of Bond:

Face Value = $25,000,000

Market Value = $25,000,000 * 87%
Market Value = $21,750,000

Annual Coupon Rate = 8%
Semiannual Coupon Rate = 4%
Semiannual Coupon = 4% * $25,000,000
Semiannual Coupon = $1,000,000

Time to Maturity = 30 years
Semiannual Period to Maturity = 60

Let semiannual YTM be i%

$21,750,000 = $1,000,000 * PVIFA(i%, 60) + $25,000,000 * PVIF(i%, 60)

Using financial calculator:
N = 60
PV = -21750000
PMT = 1000000
FV = 25000000

I = 4.65%

Semiannual YTM = 4.65%
Annual YTM = 2 * 4.65%
Annual YTM = 9.30%

2nd Issue of Bond:

Face Value = $77,000,000

Market Value = $77,000,000 * 74%
Market Value = $56,980,000

Time to Maturity = 7 years
Semiannual Period to Maturity = 14

Let semiannual YTM be i%

$56,980,000 = $77,000,000 * PVIF(i%, 14)

Using financial calculator:
N = 14
PV = -56980000
PMT = 0
FV = 77000000

I = 2.174%

Semiannual YTM = 2.174%
Annual YTM = 2 * 2.174%
Annual YTM = 4.35%

Answer a.

Total Book Value of Debt = Face Value of 1st Issue of Bond + Face Value of 2nd Issue of Bond
Total Book Value of Debt = $25,000,000 + $77,000,000
Total Book Value of Debt = $102,000,000

Answer b.

Total Market Value of Debt = Market Value of 1st Issue of Bond + Market Value of 2nd Issue of Bond
Total Market Value of Debt = $21,750,000 + $56,980,000
Total Market Value of Debt = $78,730,000

Answer c.

Weight of 1st Issue of Bond = Market Value of 1st Issue of Bond / Total Market Value of Debt
Weight of 1st Issue of Bond = $21,750,000 / $78,730,000
Weight of 1st Issue of Bond = 0.2763

Weight of 2nd Issue of Bond = Market Value of 2nd Issue of Bond / Total Market Value of Debt
Weight of 2nd Issue of Bond = $56,980,000 / $78,730,000
Weight of 2nd Issue of Bond = 0.7237

Before-tax Cost of Debt = Weight of 1st Issue of Bond*Annual YTM + Weight of 2nd Issue of Bond*Annual YTM
Before-tax Cost of Debt = 0.2763*9.30% + 0.7237*4.35%
Before-tax Cost of Debt = 5.718%

After-tax Cost of Debt = 5.718% * (1 - 0.34)
After-tax Cost of Debt = 3.79%


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