Question

In: Finance

iminy’s Cricket Farm issued a bond with 15 years to maturity and a semiannual coupon rate...

iminy’s Cricket Farm issued a bond with 15 years to maturity and a semiannual coupon rate of 4 percent 2 years ago. The bond currently sells for 91 percent of its face value. The company’s tax rate is 21 percent. The book value of the debt issue is $30 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 $20 million, and the bonds sell for 73 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 your best estimate of the aftertax cost of debt?

Solutions

Expert Solution

A

Total firm book value = BV bond 1 +BV bond 2 = 30+20 = 50m

B

MV of Bond1=Par value*bonds outstanding*%age of par
MV of Bond1=1000*30000*0.91
=27300000
MV of Bond2=Par value*bonds outstanding*%age of par
MV of Bond2=1000*20000*0.73
=14600000
MV of firm debt = + MV of Bond1+ MV of Bond 2
27300000+14600000
=41900000


C

Cost of debt
Bond1
                  K = Nx2
Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2
                   k=1
                  K =13x2
910 =∑ [(4*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^13x2
                   k=1
YTM1 = 11.268
Bond2
                  K = N
Bond Price =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N
                   k=1
                  K =7
730 =∑ [(0*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^7
                   k=1
YTM2 = 4.6
Firm cost of debt=YTM1*(MV bond1)/(MV bond1+MV bond2)+YTM2*(MV bond2)/(MV bond1+MV bond2)
Firm cost of debt=11.268*(27300000)/(27300000+14600000)+4.6*(27300000)/(27300000+14600000)
Firm cost of debt=8.94%
After tax cost of debt = cost of debt*(1-tax rate)
After tax cost of debt = 8.94*(1-0.21)
= 7.063

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