Jiminy’s Cricket Farm issued a bond with 30 years to maturity and a semiannual c

ID: 2760114 • Letter: J

Question

Jiminy’s Cricket Farm issued a bond with 30 years to maturity and a semiannual coupon rate of 6 percent 3 years ago. The bond currently sells for 92 percent of its face value. The company’s tax rate is 35 percent.

What is the pretax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

What is the aftertax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Which is more relevant, the pretax or the aftertax cost of debt?

You are given the following information for Watson Power Co. Assume the company’s tax rate is 30 percent.

9,000 6.4 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 107 percent of par; the bonds make semiannual payments.

14,000 shares of 4 percent preferred stock outstanding, currently selling for $74 per share.

What is the company's WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Drogo, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 10 years to maturity that is quoted at 110 percent of face value. The issue makes semiannual payments and has an embedded cost of 8 percent annually.

What is the company’s pretax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

If the tax rate is 35 percent, what is the aftertax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Holdup Bank has an issue of preferred stock with a $6.25 stated dividend that just sold for $99 per share. What is the bank’s cost of preferred stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Dinklage Corp. has 10 million shares of common stock outstanding. The current share price is $82, and the book value per share is $5. The company also has two bond issues outstanding. The first bond issue has a face value of $85 million, a coupon of 5 percent, and sells for 97 percent of par. The second issue has a face value of $55 million, a coupon of 6 percent, and sells for 105 percent of par. The first issue matures in 20 years, the second in 9 years.

What are the company's capital structure weights on a book value basis? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)

What are the company’s capital structure weights on a market value basis? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)

Which are more relevant, the book or market value weights?

Explanation / Answer

Jimmy's Cricket Farm:

a) The pre-tax cost of debt:

is the value of 'i" in the following equation

92 = 100*PVIF(i,54) + 3*PVIFA(i,54)

it can be found by trial and error

starting with discount rate of 4%; 100*0.1203 + 3*21.993 = 78.01

with discount rate of 3%: 100*0.2027 + 3*26.5777 = 100.00

value of 'i' for PV = 92 = 3 + 8/21.99 = 3.3638

annualised rate = 3.3638*2 = 6.73%.

b) The after tax cost of debt:

92 = 100*PVIF(i,54) + 3*0.65*PVIFA(i,54)

it can be found by trial and error

starting with discount rate of 2%; 100*0.3432 + 1.95*32.8383 = 98.35

with discount rate of 3%: 100*0.2027 + 1.95*26.5777 = 20.27 + 51.83 = 72.1

value of 'i' for PV = 92 = 2 + 6.35/26.34 = 2.2411

annualised rate = 2.2411*2 = 4.48%.

c) The after tax cost is more relevant.

Watson Power Co:

a) After tax cost of debt

is the value of 'i' in the equation 1070 = 1000*PVIF(i,40) + 32*0.70*PVIFA(i,40)

value of i to be found by trial and error

starting with i = 2

=1000*0.4529 + 22.4*27.3555 = 1065.66

with i = 1

=1000*0.6717 +22.4*32.8347 = 1407.20

value of i for which PV is 1070 = 1 + 337.19/341.54 = 1.09873

annual rate = 1.09873*2 = 2.20%.

Total MV of debt = 9000*1000*1.07= 9630000

b) Cost of Equity:

as per CAPM = 4.4 * 1.1*11 = 16.5%.

Total MV of equity = 360000*54 = 19440000

c) Cost of preferred stock =4/74 = 5.41%

Total MV of preferred stock = 14000*74 = 1036000

Wacc = 11.54%

Calculations are shown below:

Drogo Inc:

Pretax cost of debt:

is the value of i in the equation 110 = 100*PVIF(i,20) + 4*PVIFA(i,20)

value of i is to be found out by trial and error.

using 3% as the discount rate

PV = 100*0.5537 + 4*14.8775 = 114.88

using 4% as the discount rate

PV = 100*0.4564+4*13.5903 = 100.00

Value of i for which PV = 110 = 3 + 4.88/14.88 = 3.328

Annual rate = 3.328*2 = 6.66%.

After tax cost of debt:

6.66 * (1 - 0.35) = 4.33%.

Hold up bank:

Cost of preferred stock = 6.25/99 = 0.0631 = 6.31%.

Dinklage Corp:

Market Value weights is more relevant.

c) Cost of preferred stock =4/74 = 5.41%

Total MV of preferred stock = 14000*74 = 1036000

Wacc = 11.54%

Calculations are shown below:

cost % Total MV weight WACC debt 2.2 9630000 0.32 0.70 equity 16.5 19440000 0.65 10.65 preferred 5.41 1036000 0.03 0.19 30106000 11.54

Drogo Inc:

Pretax cost of debt:

is the value of i in the equation 110 = 100*PVIF(i,20) + 4*PVIFA(i,20)

value of i is to be found out by trial and error.

using 3% as the discount rate

PV = 100*0.5537 + 4*14.8775 = 114.88

using 4% as the discount rate

PV = 100*0.4564+4*13.5903 = 100.00

Value of i for which PV = 110 = 3 + 4.88/14.88 = 3.328

Annual rate = 3.328*2 = 6.66%.

After tax cost of debt:

6.66 * (1 - 0.35) = 4.33%.

Hold up bank:

Cost of preferred stock = 6.25/99 = 0.0631 = 6.31%.

Dinklage Corp:

nos BV per no Total BV BV WTs MV per no Total MV MV WTS common shares 10 5 50 26.3158 82.0 820.00 57.44509 first bond 85 44.7368 82.45 5.776034 second bond 55 28.9474 525.00 36.77887 190 100.0000 1427.45 100.0000 Weights: common shares 26.3158 57.44509 debt 73.6842 42.55491

Market Value weights is more relevant.

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Jiminy’s Cricket Farm issued a bond with 30 years to maturity and a semiannual c

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