Shanken Corp. issued a 30-year, 8 percent semiannual bond 3 years ago. The bond

Question

Shanken Corp. issued a 30-year, 8 percent semiannual bond 3 years ago. The bond currently sells for 114 percent of its face value. The company’s tax rate is 32 percent. The book value of the debt issue is $22 million. In addition, the company has a second debt issue on the market, a zero coupon bond with three years left to maturity; the book value of this issue is $80 million and the bonds sell for 78 percent of par.What is the total market value? What is your best estimate of the aftertax cost of debt?

Explanation / Answer

Calculating the total market value of the debt issue: Total market value = Present value of first debt issue + Present value of Second debt issue                              = 114% ($22,000,000) + 78% ($80,000,000)                              = $25,080,000 + $62,400,000                              = $87,480,000 Calculating the Yield to maturity for first debt issue: Step1: Go to excel and click "insert" to insert the function. Step2: Select the "Rate" function as we are finding the yield to maturity in this case. Step3: Enter the values as Nper = 27; PMT = -880000; PV = 25080000; FV = -22000000 Step4: Click "OK" to get the desired value. Semi-annual coupon payment amount = Face value * Coupon rate * (6/12)                                                          = $22,000,000 * 8% *(1/2)                                                          = $880,000 The value comes to "3.22%" Annual YTM is (3.22 * 2) = 6.44% Calculating the after-tax cost of debt for the first debt issue: After-tax cost of debt = 6.44% (1-0.32)                                   = 0.0438                                   = 4.38% Calculating the Yield to maturity for the second debt issue: Step1: Go to excel and click "insert" to insert the function. Step2: Select the "Rate" function as we are finding the yield to maturity in this case. Step3: Enter the values as Nper = 3; PMT = 0; PV = 62400000; FV = -80000000 Step4: Click "OK" to get the desired value. The value comes to "8.63%" Therefore, the YTM of the bond is 8.63% Calculating the after-tax cost of debt for the second debt issue: After-tax cost of debt = 8.63% (1-0.32)                                   = 0.0587                                   = 5.87% Step1: Go to excel and click "insert" to insert the function. Step2: Select the "Rate" function as we are finding the yield to maturity in this case. Step3: Enter the values as Nper = 3; PMT = 0; PV = 62400000; FV = -80000000 Step4: Click "OK" to get the desired value. The value comes to "8.63%" Therefore, the YTM of the bond is 8.63% Calculating the after-tax cost of debt for the second debt issue: After-tax cost of debt = 8.63% (1-0.32)                                   = 0.0587                                   = 5.87% Calculating the after-tax cost of debt for the second debt issue: After-tax cost of debt = 8.63% (1-0.32)                                   = 0.0587                                   = 5.87%

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