Jiminy\'s Cricket Farm issued a 30-year, 7.2 percent semiannual bond 9 years ago

Question

Jiminy's Cricket 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 book value of this 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 percent of par. The company’s tax rate is 30 percent.

What is the total book value of debt? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)

What is the total market value of debt? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)

What is the aftertax cost of the 7.2 percent coupon bond? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

What is the aftertax cost of the zero coupon bond? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

What is the aftertax cost of debt? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Jiminy's Cricket 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 book value of this 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 percent of par. The company’s tax rate is 30 percent.

Explanation / Answer

1)Book value of total debt = book value of 30 yr bond + book value of zero coupon bond = 107 m+ 66 m = $173000000

2)Market value of debt = market value of 30 yr bond+ market value of zero coupon bond

=107*0.855 + 66*0.61 = 131.745 million = $131745000

3)After tax cost of 30 ye bond = YTM*(1- tax rate) =

Using excels formula of RATE

the variables are

nper= 21* 2 = 42

pmt = 0.072/2*1000 = 36

pv= market value = 1000*0.855 = -855(negative to show outflow)

FV= 1000$

Thus excel caluclates = 4.36% i.e anually it is 8.72%

Thus after tax cost of debt = 8.72%(1-0.3) =6.10%

4)After tax cost of zero coupon bond,

we will use the same approach, using the RATE function

the variables are

nper=12

pmt = 0(Since there are no coupons)

pv= market value = 1000*0.61 = -610(negative to show outflow)

FV= 1000$

Thus excel caluclates = 4.21% i.e anually it is 8.42%

Thus after tax cost of debt = 8.42%(1-0.3) = 5.89%

5)To find the total cost of debt, we would have to do a weighted average based on market value of the debt.

thus total cost of debt =

The after tax cost of debt for the company is the weighted average of the after tax cost of debt for all outstanding bond issues.

We need to use the market value weights of the bonds

After Tax cost =(6.10%*85.5%*107+5.89%*61%*66)/((85.5%*107)+(61%*66))

=6.03%

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