Pearce’s Cricket Farm issued a 25-year, 12 percent semiannual bond 3 years ago.

Question

Pearce’s Cricket Farm issued a 25-year, 12 percent semiannual bond 3 years ago. The bond currently sells for 94 percent of its face value. The company’s tax rate is 38 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 annually with 14 years left to maturity; the book value of this issue is $45 million and the bonds sell for 53 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.) Total book value $ What is the company’s total market value of debt? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.) Total market value $ What is your best estimate of the after-tax cost of debt? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

a) Total Book Value = 40m + 45m = $85,000,000

b) Total Market Value = 40m x 94% + 45m x 53% = $61,450,000

c) Cost of coupon bond can be calculated using I/Y function

N = 25 x 2 = 50, PMT = 12% x 1000 / 2 = 60, PV = -940, FV = 1000 => Compute I/Y = 6.40% (semi-annual)

Annualized YTM = 6.40% x 2 = 12.80% = kd1

Cost of zero coupon bond = (100 / 53)^(1/14) - 1 = 4.64%

Weighted average before tax cost of debt = (12.80% x 40 x 94% + 4.64% x 45 x 53%) / 61.45 = 9.64%

After-tax cost of debt = 9.64% x (1 - 38%) = 5.97%

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