Shanken Corp. issued a bond with a maturity of 20 years and a semiannual coupon

Question

Shanken Corp. issued a bond with a maturity of 20 years and a semiannual coupon rate of 6 percent 2 years ago. The bond currently sells for 92 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 12 years left to maturity; the book value of this issue is $40 million and the bonds sell for 52 percent of par. The company’s tax rate is 40 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@92% of face value                     36,800,000 Years To maturity                                18.00 Annual Interest @6%=                        2,400,000 YTM Formula= [Annual Interest+(Par Value-Market Value)/Years to Maturity]/(Par value+Market Price*2)/3 YTM = [2400000+(40000000-36800000)/18]/(40000000+2*36800000)/3 YTM = 6.8% approx Tax rate =40% Post Tax cost of bond = 4.08% Second Bond Bond Par Value                     40,000,000 Bond Market Price@52% of face value                     20,800,000 Years To maturity                                12.00 Annual Interest=0                                       -   YTM Formula= [Annual Interest+(Par Value-Market Value)/Years to Maturity]/(Par value+Market Price*2)/3 YTM = [0+(40000000-20800000)/12]/(40000000+2*20800000)/3 YTM = 5.6% approx Tax rate =40% Post Tax cost of bond = 3.36% After Tax cost of Debt Bond   Market Value % wt value Post Tax cost Wtd cost Bond 1.                     40,000,000 50% 4.08% 2.04% Zero coupon bond                     40,000,000 50% 3.36% 1.68% Total 3.72% So Post tax cost of total debt = 3.72%

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