Jiminy\'s Cricket Farm issued a 30-year, 7 percent semi-annual bond 6 years ago.

Question

Jiminy's Cricket Farm issued a 30-year, 7 percent semi-annual bond 6 years ago. The bond currently sells for 80 percent of its face value. The book value of the debt issue is $19 million. The company's tax rate is 32 percent.

In addition, the company has a second debt issue on the market, a zero coupon bond with 6 years left to maturity; the book value of this issue is $76 million and the bonds sell for 76 percent of par.

Required:

(a) What is the company's total book value of debt? (Do not round your intermediate calculations.)

(b) What is the company's total market value of debt? (Do not round your intermediate calculations.)

(c) What is your best estimate of the aftertax cost of debt? (Do not round your intermediate calculations.)

Explanation / Answer

a) Total book value of debt = Book value of first debt issue + Book value of second debt issue

   = 19 + 76

   = $ 95 Million

b) Total market value of debt = Market value of first debt issue + Market value of second debt issue

Let Par value / Face value of each debt issue (First and second) = $100

= [80% of 100] + [76 % of 100]

   = 80 + 76

   = $ 156 Million

c) Best after-tax cost of debt:-

   After tax cost of first debt issue:-

   = Rate on interest * ( 1 - tax rate)

   = 7 (1 - 0.32)

   = 4.76 %

After tax cost of second debt issue:-

  = Rate on interest * ( 1 - tax rate)

   = 0 * (1 - 0.32) [ Zero-coupon bond does not carry any interest.]

   = 0 %

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