Peyton\'s Colt Farm issued a 30-year, 7.2 percent semiannual bond 9 years ago. T

Question

Peyton's Colt Farm issued a 30-year, 7.2 percent semiannual bond 9 years ago. The bond currently sells for 85.5 percent of its face value. The company's tax rate is 30 percent. The book value of the debt issue is $107 million. In addition, the company has a second debt issue, a zero coupon bond with 12 years left to maturity; the book value of this issue is $66 million, and it sells for 61.0 percent of par.

What is the total book value of debt?

What is the total market value of debt?

What is the aftertax cost of debt? (%) (2 decimal places)

Explanation / Answer

1. Total book value of debt is equal to the sum of the total par value of all outstanding debt.

Total book value of debt = $107 million + $66 million = $173 million.

2. The market value of debt will be calculated by multiplying the price quote of the bond times the par value of the bonds.

he market value of debt = 0.855($107,000,000) + .61($66,000,000) = $91,485,000 + $40,260,000 = $131,745,000

3. Now we will calculate yield to maturity on zero coupon bonds:

Using financial calcuator enter Pv = 610, Fv = 1000 and N = 12, press I/Yr = 4.21%

YTm = 2*4.21% = 8.42%

After tax cost of zero coupon bonds = YTM(1-tax rate) = 8.42% (1-0.30)=5.894%

we will calculate After tax cost of debt for the company by taking weighted average of the aftertax cost of debt for all outstanding bond issues with the help of market value weights of the bonds.

The total aftertax cost of debt for the company is:
= .0504($91,485,000/$131,745,000) + .0589($40,260,000/$131,745,000) = 0.0349 + 0.0179 = 0.0529 or 5.29%

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