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?

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?

Explanation / Answer

In a sense, The question is asking to calculate the market value of Debt

N= 23 years

YTM = 8.3 %

FV = 1000

PV = -159.79

Total PV of all the 142000 zero coupon bonds = 159.79 * 142000 = $ 22.689 million

Value of equity = 45.7 million

Total equity + Debt value = 45.7 + 22.689 = 68.39 million

Weight of Debt in capital structure = Market value of debt / Total value = 22.689 / 68.39

                                                       = 33.17 %

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