Jiminy’s Cricket Farm issued a 20-year, 10 percent semiannual bond 4 years ago.

Question

Jiminy’s Cricket Farm issued a 20-year, 10 percent semiannual bond 4 years ago. The bond currently sells for 97 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 with 11 years left to maturity; the book value of this issue is $40 million, and the bonds sell for 52 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.)

What is the company’s total market value of debt? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)

What is your best estimate of the aftertax cost of debt? (Round your answer to 2 decimal places. (e.g., 32.16))

Jiminy’s Cricket Farm issued a 20-year, 10 percent semiannual bond 4 years ago. The bond currently sells for 97 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 with 11 years left to maturity; the book value of this issue is $40 million, and the bonds sell for 52 percent of par.

Explanation / Answer

Answer:Jiminy’s Cricket Farm: Calculation of the after tax cost of the debt:

N=(20-4)*2=32 years

PMT=1000*10%=$100/2=$50

FV=$1000

PV=1000*97%=970

cost of debt=10.38%

After tax=10.38%(1-0.38)=6.4356%

Answer: calculation of the company’s total book value of debt:

•The book value of debt is the total par value of all outstanding debt, so:

• BVD = 40M + 40M = 80M

Answer: Calculation of the company’s total market value of debt:

•To find the market value of debt, we find the price of the bonds and multiply by the number of bonds. Alternatively, we can multiply the price quote of the bond times the par value of the bonds. Doing so, we find:

• MVD = 0.97* 40M + .52*40M = 59.6 M

Answer:

•The YTM of the zero coupon bonds is:

• PZ = 520 = 1,000

•     T=11

• R = 6.125%

• So, the after tax cost of the zero coupon bonds is:

• RZ = .06125(1 – .35) = 3.98%

•The after tax cost of debt for the company is the weighted average of the after tax cost of debt for all outstanding bond issues. We need to use the market value weights of the bonds. The total after tax cost of debt for the company is:

• RD = 6.4356*(38.8/59.6) + 3.98%*(20.8/ 59.6)

=4.1896%+1.38899%

= 5.58%

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