Question

Suspect Corp. issued a bond with a maturity of 10 years and a semiannual coupon rate of 6 percent 2 years ago. The bond currently sells for 95 percent of its face value. The book value of the debt issue is $55 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 15 years left to maturity; the book value of this issue is $30 million and the bonds sell for 55 percent of par. The company’s tax rate is 40 percent.

What is the company’s total book value of debt? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

Total book value           $

What is the company’s total market value of debt? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

Total market value           $

What is your best estimate of the aftertax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of debt            %

Answer 1

a). The book value of debt is the total par value of all outstanding debt, so:

BVD = $55,000,000 + $30,000,000 = $85,000,000

b). To find the market value of debt, we find the Market Price (the selling price) of the bonds and multiply by the number of bonds. Alternatively, we can multiply the price quote of the bond times the par value of the bonds. Doing so, we find:

MVD = 0.95($55,000,000) + 0.55($30,000,000)

= $52,250,000 + $16,500,000 = $68,750,000

c). For Company's Bonds,

To find the YTM, we need to put the following values in the financial calculator:

INPUT	8x2=16		-950	30	1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT		3.41

So, r = 3.41%

which means YTM = 2r = 2 x 3.41% = 6.82%

After-tax kD = 6.82% x (1 - 0.40) = 4.09%

For Zero Coupon Bonds,

To find the YTM, we need to put the following values in the financial calculator:

INPUT	15x2=30		-550	0	1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT		2.01

So, r = 2.01%

which means YTM = 2r = 2 x 2.01% = 4.03%

After-tax kD = 4.03% x (1 - 0.40) = 2.42%

kD = [Wc x kDc] + [Wz x kDz]

= [($52,250,000 / $68,750,000) x 4.09%] + [($16,500,000 / $68,750,000) x 2.42%]

= 3.11% + 0.58% = 3.69%