Bennington Industrial Machines issued 142,000 zero coupon bonds seven years ago.

Question

Bennington Industrial Machines issued 142,000 zero coupon bonds seven years ago. The bonds originally had 30 years to maturity with a yield to maturity of 7.2 percent. Interest rates have recently increased, and the bonds now have a yield to maturity of 8.3 percent.

Required:

If the company has a $45.7 million market value of equity, what weight should it use for debt when calculating the cost of capital? (Do not round intermediate calculations. Round your answer to 4 decimal places (e.g., 32.1616).)

Explanation / Answer

Number of zero coupon bond = 142,000

Par value of bond = $1,000

YTM of bond = 7.2%

Current yield = 8.3%

Number of year remains in maturity = 23 year

Present market value of bond is calculated below:

Markey value of bond = $1,000 / (1 + 8.3%) ^23

                                       = $1,000 / 6.2583

                                       = $159.79

Total market value of debt = 142,000 × $159.79

                                               = $22,689,965.84

Total market value of bond is $22,689,965.84

Total market value of Equity is $45,700,000

Weight of debt in capital structure = $22,689,965.84 / (26,689,965.84 + $45,700,000)

                                                            = 33.18%

Hence, weight of debt in capital structure is 33.18%.

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