Jiminy’s Cricket Farm issued a 20-year, 8 percent semiannual bond 3 years ago. T
ID: 2758018 • Letter: J
Question
Jiminy’s Cricket Farm issued a 20-year, 8 percent semiannual bond 3 years ago. The bond currently sells for 96 percent of its face value. The company’s tax rate is 35 percent.
Suppose 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 10 years left to maturity; the book value of this issue is $40 million, and the bonds sell for 52 percent of par.
What is the company’s total book value of debt? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)
What is the company’s total market value of debt? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)
What is your best estimate of the aftertax cost of debt? (Round your answer to 2 decimal places. (e.g., 32.16))
Jiminy’s Cricket Farm issued a 20-year, 8 percent semiannual bond 3 years ago. The bond currently sells for 96 percent of its face value. The company’s tax rate is 35 percent.
Suppose 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 10 years left to maturity; the book value of this issue is $40 million, and the bonds sell for 52 percent of par.
Explanation / Answer
Solution:
1) Calculation of company’s total book value of debt:
Total Book Value = 40,000,000 + 40,000,000
= 80,000,000
2) Calculation of company’s total market value of debt:
We find the price of the bonds and multiply by the number of bonds. Alternatively, we can multiply the price quote of the bond times the par value of the bonds. Doing so, we find:
= 0.96 * 40,000,000 + 0.52 * 40,000,000
= 59,200,000
3) Best estimate of the aftertax cost of debt:
P0 = 960 = 40 (PVIFAR%,34) + 1,000 (PVIFR%,34)
R = [40 + (40/34)]/ [(960+1,000)/2 = 4.21%
YTM = 2 * 4.22 = 8.44%
After tax Coast of Debt is = 8.44% (1-0.35)
= 8.44% * 0.65
= 5.49%
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