Bennington Industrial Machines issued 142,000 zero coupon bonds seven years ago.

Question

Bennington Industrial Machines issued 142,000 zero coupon bonds seven years ago. The bonds originally had 30 years to maturity with a yield to maturity of 7.2 percent. Interest rates have recently increased, and the bonds now have a yield to maturity of 8.3 percent.

If the company has a $45.7 million market value of equity, what weight should it use for debt when calculating the cost of capital? (Do not round intermediate calculations. Round your answer to 4 decimal places (e.g., 32.1616).)

Bennington Industrial Machines issued 142,000 zero coupon bonds seven years ago. The bonds originally had 30 years to maturity with a yield to maturity of 7.2 percent. Interest rates have recently increased, and the bonds now have a yield to maturity of 8.3 percent.

Explanation / Answer

Market Value of Zero coupon Bond = Face Value / (1+r)^t

r = market yield = 8.3%

t = years to maturity = 23 years

Face Value of Zero coupon Bond = 142000 * $100 (assuming face value of one bond is $100) = $14200000

Market Value of Zero coupon Bond = 14200000 / (1+.083)^23

= $22,68,996.58

Weight of Debt = 2268996.58 / (2268996.58 + 45700000)

Weight of Debt = .0473

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