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 your best estimate of the aftertax cost of debt?

Explanation / Answer

First Bond Bond Par Value                     40,000,000 Bond Market Price@91% of face value 36400000 Years To maturity 14 Annual Interest @6%= 2400000 YTM Formula= [Annual Interest+(Par Value-Market Value)/Years to Maturity]/(Par value+Market Price*2)/3 YTM = [2400000+(40000000-36400000)/14]/(40000000+2*36400000)/3 YTM = 3.64% approx Tax rate =38% Post Tax cost of bond = 2.26% Second Bond Bond Par Value                     30,000,000 Bond Market Price@50% of face value 15000000 Years To maturity                                11 Annual Interest=0                                       -   YTM Formula= [Annual Interest+(Par Value-Market Value)/Years to Maturity]/(Par value+Market Price*2)/3 YTM = [0+(30000000-15000000)/12]/(30000000+2*15000000)/3 YTM = 6.25% approx 125000 0.00625 Tax rate =38% Post Tax cost of bond = 4.21% After Tax cost of Debt Bond   Market Value % wt value Post Tax cost Wtd cost Bond 1.                     40,000,000 50% 2.26% 1.38% Zero coupon bond                     30,000,000 50% 4.21% 2.04% Total 3.42% So Post tax cost of total debt = 3.42%

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