Question

Jiminy's Cricket Farm issued a 20-year, 7 percent semiannual coupon bond 5 years ago.The bond currently sells for 94 percent of its face value. The company's tax rate is 24 percent. The book value of the debt issue is $45 million. In addition, the company has a second debt issue, a zero coupon bond with 10 years left to maturity; the book value of this issue is $30 million, and the bond sells for 65 percent of par.

a. What is the company's total book value of debt?

b. What is the company's total market value of debt?

c. What is the aftertax cost of debt?

Answer 1

a

Given

Current book value of both the debts,
Thus,

Total book value of debt = sum of the book value of both the debts

= 45million + 30 million

= $ 75 million .......answer

b

Let's assume there is no unamortized premium or discount. So the Book value = face value or par value of debt

Now

The first bond is selling at 94% of the face value.

So,

the market value of first debt = 0.94*45 = 42.3 million

Similarly,

the market value of second debt = 0.65*30 = 19.5 million

Hence,

Total market value of debt = 42.3 + 19.5 = 61.8 million

c

Now,

By using the formula for bond pricing in excel or financial calculated we will find the cost of debt for the first debt.

The inputs are as follows

PV = 940

FV = -1000

N = 30 ( 15 Years left and semi-annual bond)

Pmt = -35 (70/2)

Cost of debt = 7.68%

After tax cost of debt = 7.5 * (1-0.24) = 5.83%

Similary, for second debt

PV = 650

FV = -1000

N = 10

Pmt = 0

Cost of debt = 4.4%

After tax cost of debt = 4.4*(1-0.24) = 3.34%

Thus,

After tax cost of debt for the company = 5.83*(42.3/61.8) + 3.34*(19.5/61.8)

= 5.04%