Question

Jiminy’s Cricket Farm issued a bond with 15 years to maturity and a semiannual coupon rate of 5 percent 3 years ago. The bond currently sells for 92 percent of its face value. The company’s tax rate is 22 percent. The book value of the debt issue is $35 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 8 years left to maturity; the book value of this issue is $20 million, and the bonds sell for 65 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.)

Answer 1

a

Book Value firm of debt = BV bond 1+BV bond 2=35000000+20000000=55000000

b

MV of Bond 1=Par value*bonds outstanding*%age of par

MV of Bond 1=1000*35000*0.92

=32200000

MV of Bond2=Par value*bonds outstanding*%age of par

MV of Bond2=1000*20000*0.65

=13000000

MV of firm debt = MV of bond 1 + MV of bond 2

=32200000+13000000

=45200000

c

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =12x2

920 =∑ [(5*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^12x2

k=1

YTM = 5.9418

Bond2

K = N

Bond Price =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N

k=1

K =8

=∑ [(0*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^8

k=1

YTM2 = 5.5324

Firm cost of debt=YTM1*(MV bond1)/(MV bond1+MV bond2)+YTM2*(MV bond2)/(MV bond1+MV bond2)

Firm cost of debt=5.9418*(32200000)/(32200000+13000000)+5.5324*(13000000)/(32200000+13000000)

Firm cost of debt=5.8241%

After tax rate = Cost of debt * (1-Tax rate)

After tax rate = 5.8241 * (1-0.22)

After tax rate = 4.54