Question

4

Shanken Corp. issued a 25-year, 5.5 percent semiannual bond 4 years ago. The bond currently sells for 106 percent of its face value. The book value of the debt issue is $50 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 14 years left to maturity; the book value of this issue is $45 million and the bonds sell for 50 percent of par. The company’s tax rate is 25 percent.

a.	What is the company's total book value of debt? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
b.	What is the company's total market value of debt? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
c.	What is your best estimate of the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

    

Answer 1

	Market value of coupon bond	50000000*106%	53000000
	Market value of zero coupon bond	45000000*50%	22500000
1-	total book value of debt	book value of coupon bond + book value of zero coupon bond	50000000+45000000	95000000
2-	total market value of debt	Market value of coupon bond + market value of zero coupon bond	(50000000*106%)+(45000000*50%)	75500000
	YTM on coupon bonds- semiannual	Using rate function In MS excel	rate(npr,pmt,pv,fv,type) nper = 21*2 = 42 pmt = 50000000*5.5%*1/2 = 2750000 pv = -53000000 fv = 50000000 type =0	RATE(42,1375000,-53000000,50000000,0)	2.52%
	annual YTM	2.52*2	5.04
	after tax cost of coupon bond	5.04*(1-tax rate)	3.78
	YTM on zero coupon bond	Using rate function In MS excel	rate(npr,pmt,pv,fv,type) nper = 14 pmt = 0 pv = -22500000 fv = 45000000 type =0	RATE(14,0,-22500000,45000000,0)	5.08%
	after tax cost of zero coupon bond	5.08*(1-.25)			3.81
3-	after tax cost of debt
	source	market value	weight	cost of debt	weight *cost of source of debt
	coupon bond	53000000	0.701986755	3.78	2.65350993
	zero coupon bond	22500000	0.298013245	3.81	1.13543046
		75500000	Weighted average cost of debt = sum of weight * cost of source of debt		3.79