Jiminy’s Cricket Farm issued a bond with 25 years to maturity and a semiannual coupon rate of 4 percent 5 years ago. The bond currently sells for 104 percent of its face value. The company’s tax rate is 24 percent. The book value of the debt issue is $50 million. In addition, the company has a second debt issue on the market, a zero-coupon bond with 7 years left to maturity; the book value of this issue is $35 million, and the bonds sell for 79 percent of par.
a. What is the company’s total book value of debt? (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567.)
b. What is the company’s total market value of debt? (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567.)
c. What is your best estimate of the after-tax cost of debt?

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andromache andromache · Answer 1 · 2020-05-13T05:33:03+02:00

Answer:

a) Total book value = $85,000,000

b)Market value of debt = $27,650,000

c)After tax cost of debt = 2.74%

Explanation:

As per the data given in the question,

a) Debt = $50,000,000

Zero coupon bond = $35,000,000

Total book value = $50,000,000+$35,000,000

= $85,000,000

b) Market value of debt = $50,000,000×104%

=$52,000,000

Market value of zero coupon bond = $35,000,000×79%

=$27,650,000

Total market value = $52,000,000+$27,650,000

= $79,650,000

c) Market value weights for debt = 0.65

Market value weights for Zero coupon bond = 0.35

After tax cost for Debt ( By using financial calculator )

( 0.01857 ×2 × (1-24%)) = 2.82%

After tax cost for Zero coupon bond ( By using financial calculator )

( 0.01698 ×2 × (1-24%)) = 2.58%

Weighted cost for debt ( Weight × Cost )= 1.84%

Weighted cost for zero coupon bond ( Weight × Cost ) = 0.90%

After tax cost of debt = 1.84%+0.90%

=2.74%