Jiminy\'s Cricket Farm issued a 30-year, 8 percent semi-annual bond 8 years ago.

Question

Jiminy's Cricket Farm issued a 30-year, 8 percent semi-annual bond 8 years ago. The bond currently sells for 80 percent of its face value. The book value of the debt issue is $23 million. The company's tax rate is 32 percent, and the bond has a YTM of 10.31%.

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 $66 million, the face value (also called par value) is $81 million, and the bonds sell for 75 percent of par.

Required: What is your best estimate of the aftertax cost of debt (leave as an APR)? (Do not round your intermediate calculations.)

Note: This is going to be a yield, not a dollar amount. It is the weighted average YTM adjusted for taxes. You can get the YTM for the zero coupon bond using the present value equation for a single cash flow: PV = FV(1+r)-T. Since the YTM for the coupon bond is an APR, you should calculate the YTM for the zero as an APR with semi-annual compounding so that both bond yields are on the same compounding frequency:
zero-coupon price = CF(1+YTM/2)-2T.

Choices: 4.68%, 4.46%, 2.59%, 3.52% or 3.35%.

Explanation / Answer

nter:
N = 24 x 2 = 48
PV = -800
PMT = 80/2 = 40
FV = 1000

Solve:
I/Y = 10.26

0.1026(1 - 0.32) = 7 percent

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