In: Finance
Problem 14-8 Calculating Cost of Debt [LO2]
Jiminy’s Cricket Farm issued a bond with 30 years to maturity and a semiannual coupon rate of 5 percent 3 years ago. The bond currently sells for 94 percent of its face value. The company’s tax rate is 22 percent. The book value of the debt issue is $65 million. 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 $45 million, and the bonds sell for 74 percent of par. |
a. |
What is the company’s total book value of debt? (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? (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.) |
a) total book value?
b) total market value?
c) cost of debt?
please help
a |
Book Value firm of debt = BV bond 1+BV bond 2=65000000+45000000=110000000 |
b |
MV of Bond 1=Par value*bonds outstanding*%age of par |
MV of Bond 1=1000*65000*0.94 |
=61100000 |
MV of Bond2=Par value*bonds outstanding*%age of par |
MV of Bond2=1000*45000*0.74 |
=33300000 |
MV of firm debt = MV of bond 1 + MV of bond 2 |
=61100000+33300000 |
=94400000 |
c |
K = Nx2 |
Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k] + Par value/(1 + YTM/2)^Nx2 |
k=1 |
K =27x2 |
940 =∑ [(5*1000/200)/(1 + YTM/200)^k] + 1000/(1 + YTM/200)^27x2 |
k=1 |
YTM = 5.4259 |
Bond2 |
K = N |
Bond Price =∑ [(Annual Coupon)/(1 + YTM)^k] + Par value/(1 + YTM)^N |
k=1 |
K =7 |
=∑ [(0*1000/100)/(1 + YTM/100)^k] + 1000/(1 + YTM/100)^7 |
k=1 |
YTM2 = 4.3954 |
Firm cost of debt=YTM1*(MV bond1)/(MV bond1+MV bond2)+YTM2*(MV bond2)/(MV bond1+MV bond2) |
Firm cost of debt=5.4259*(61100000)/(61100000+33300000)+4.3954*(33300000)/(61100000+33300000) |
Firm cost of debt=5.0624% |
After tax rate = Cost of debt * (1-Tax rate) |
After tax rate = 5.0624 * (1-0.22) |
After tax rate = 3.95 |