Jiminy\'s Cricket Farm issued a 30-year, 7 percent semi-annual bond 5 years ago.

Question

Jiminy's Cricket Farm issued a 30-year, 7 percent semi-annual bond 5 years ago. The bond currently sells for 81 percent of its face value. The book value of the debt issue is $23 million. The company's tax rate is 33 percent.

In addition, the company has a second debt issue on the market, a zero coupon bond with 5 years left to maturity; the book value of this issue is $78 million and the bonds sell for 74 percent of par.

(a) What is the company's total book value of debt?

What is the company's total market value of debt?

(c) What is your best estimate of the aftertax cost of debt?

What is the company's total market value of debt?

(c) What is your best estimate of the aftertax cost of debt?

Explanation / Answer

Total book value of debt = book value of bond 1 + book value of bond 2 = 23+78 = 101

Total market value of debt = book value of bond 1*corresponding percent of par + book value of bond 2*corresponding percent of par = 0.81*23+0.74*78 = 76.35

Cost of debt =

                    K =Nx2          
BOND PRICE= [(Semi-annual Coupon)/(1 + YTM1/2)^k]     +   Par value/(1 + YTM1/2)^(Nx2)
                   k=1

        K= 30x2           
810 = [(7*1000/(100*2))/(1 + YTM1/200)^k]     +   1000/(1 + YTM1/200)^30x2
        k=1

YTM1 = 8.8102%

BOND PRICE= Par value/(1 + YTM/2)^(Nx2)
  

740= 1000/(1 + YTM2/200)^5x2

YTM2 = 6.1136%

Before tax cost of debt YTM = YTM1*(MV bond 1)/(MV bond 1+ MV bond 2) + YTM2*(MV bond 2)/(MV bond 1+ MV bond 2)

=8.8102*0.81*23/76.35 +6.1136*78*0.74/76.35 = 6.7715%

After tax cost of debt = before tax cost of debt*(1-tax rate) = 6.7715*(1-0.33) = 4.5369%

Related Questions

Navigate

• Browse (All)
• Browse J
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.