Shanken Corp. issued a bond with a maturity of 16 years and a semiannual coupon

Question

Shanken Corp. issued a bond with a maturity of 16 years and a semiannual coupon rate of 6 percent 2 years ago. The bond currently sells for 91 percent of its face value. The book value of the debt issue is $40 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 11 years left to maturity; the book value of this issue is $30 million and the bonds sell for 50 percent of par. The company’s tax rate is 38 percent. What is the company’s total book value of debt?What is the company’s total market value of debt? What is your best estimate of the aftertax cost of debt?

Explanation / Answer

Book value of debt = Book value of first debt issued + Book value of second debt issue

= $40 million + $30 million

= $70 million

Company's total market value of debt = market value of first debt issued + market value of second debt issue

= $40 million * 0,91 + $30 million * 0.50

= $51.4 million

Afterr tax cost of debt = Ater tax cost of first debt issued + After tax cost of second debt issue

=[ i*(1- tax rate) + (B.V. - M.V.)/n ] / [(B.V + M.V)/2] + (Face Value / Current Price of Bond) ^ (1 / Years to Maturity) - 1

= 6% (1-0.38) + [40 -36.4 million]/28 / (40 + 36.4)/2 + ($30 million / $15 million) ^ (1/11) - 1

= 10.07% + 6.5%

= 16.57 %

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