Bennington Industrial Machines issued 138,000 zero coupon bonds seven years ago.
ID: 2719788 • Letter: B
Question
Bennington Industrial Machines issued 138,000 zero coupon bonds seven years ago. The bonds originally had 30 years to maturity with a yield to maturity of 6.8 percent. Interest rates have recently increased, and the bonds now have a yield to maturity of 8.4 percent.
What is the price of the bonds?
What is the market value of the company's debt?
What is the market value of the company's debt?
If the company has a $45.3 million market value of equity, what weight should it use for debt when calculating the cost of capital?
Bennington Industrial Machines issued 138,000 zero coupon bonds seven years ago. The bonds originally had 30 years to maturity with a yield to maturity of 6.8 percent. Interest rates have recently increased, and the bonds now have a yield to maturity of 8.4 percent.
Explanation / Answer
Answer:
Balance No of years = 30 – 7 = 23 Years
Present Yield to Maturity = 8.40% p.a.
Since the face value of Zero Coupon Bond is not given. It is assumed $100 each bond
So, the face value of 138,000 Zero Coupon Bonds is $13,800,000
Maturity Value = $13,800,000
In Zero Coupon Bonds, no interest is paid during the life time of bond. Payment is made at the time of maturity i.e. face value.
Yield to maturity is the required rate of return which a bond holder required from their investment.
By using Yield to Maturity we can find out Current Market Value of Bond
Current Price of Zero Coupon Bond = Maturity Value x PVIF (8.40%, 23) = $13,800,000 x 0.156 = $2,152,800
Current Price Per Zero Coupon Bond is $2,152,800 / 138,000 = $15.60
Market Value of Company’s Debt = $2,152,800
Weight to be used for debt when calculating the cost of capital is 0.04536 or 0.045
Particulars Market Value Weight Equity $45,300,000 $45,300,000 / $47,452,800 = 0.9546 Debt $2,152,800 $2,152,800 / $47,452,800 = 0.04536 Total $47,452,800 1.00Related Questions
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