Jiminy’s Cricket Farm issued a 10-year, 6 percent semiannual bond 2 years ago. T
ID: 2720096 • Letter: J
Question
Jiminy’s Cricket Farm issued a 10-year, 6 percent semiannual bond 2 years ago. The bond currently sells for 95 percent of its face value. The company’s tax rate is 40 percent.
Suppose the book value of the debt issue is $55 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 15 years left to maturity; the book value of this issue is $30 million, and the bonds sell for 55 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 10-year, 6 percent semiannual bond 2 years ago. The bond currently sells for 95 percent of its face value. The company’s tax rate is 40 percent.
Suppose the book value of the debt issue is $55 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 15 years left to maturity; the book value of this issue is $30 million, and the bonds sell for 55 percent of par.
Explanation / Answer
What is the total book value of debt?
Total book value of debt = Book Value of Coupon Bond + Book Value of Zero Coupon Bond
Total book value of debt = 55000000 + 30000000
Total book value of debt = $ 85,000,000
What is the total market value of debt?
Total market value of debt = Market Value of Coupon Bond + Market Value of Zero Coupon Bond
Total market value of debt = 55000000*95% + 30000000*55%
Total market value of debt = $ 68,750,000
What is your best estimate of the aftertax cost of debt?
Aftertax cost of the 6 percent coupon bond
Before tax cost of 6 percent coupon bond = rate(nper,pmt,pv,fv)*2
nper = (10-2)*2 = 16
pmt = 1000*6%*1/2 = 30
pv = -1000*95% = 950
fv = 1000
Before tax cost of 6 percent coupon bond = rate(16,30,-950,1000)*2
Before tax cost of 6 percent coupon bond = 6.82%
After tax cost of 6 percent coupon bond = Before tax cost of debt *(1-tax rate)
After tax cost of 6 percent coupon bond = 6.82*(1-40%)
After tax cost of 6 percent coupon bond = 4.09%
Aftertax cost of the zero coupon bond
Aftertax cost of the zero coupon bond =( (1000/550)^(1/15) -1 ) *(1-40%)
Aftertax cost of the zero coupon bond = 2.44%
Aftertax cost of debt = Aftertax cost of the zero coupon bond*weight of zero coupon bond + Aftertax cost of the coupon bond*weight of coupon bond
Aftertax cost of debt = 2.44%*(30*55%)/68.75 + 4.09%* (95%*55)/68.75
Aftertax cost of debt = 3.69%
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