Jiminy\'s Cricket Farm issued a 30-year, 8 percent semi-annual bond 5 years ago.

Question

Jiminy's Cricket Farm issued a 30-year, 8 percent semi-annual bond 5 years ago. The bond currently sells for 92 percent of its face value. The book value of the debt issue is $18 million. The company's tax rate is 34 percent. In addition, the company has a second debt issue on the market, a zero coupon bond with 5 years left to maturity; the book value of this issue is $78 million and the bonds sell for 73 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

Part A)

The total book value of debt can be calculated with the use of following formula:

Total Book Value of Debt = Par Value of First Debt Issue+ Par Value of Second Debt Issue

Using the values provided in the question, we get,

Total Book Value of Debt = 18,000,000 + 78,000,000 = $96,000,000

________

Part B)

The total market value of the debt can be calculated with the use of following formula:

Total Market Value of Debt = Book Value of First Debt Issue*Current Selling Price Percentage of First Debt Issue + Book Value of Second Debt Issue*Current Selling Price Percentage of Second Debt Issue

Using the values provided in the question, we get,

Total Market Value of Debt = 18,000,000*92% + 78,000,000*73% = $73,500,000

________

Part C)

To calculate the after-tax cost of debt we need to calculate the YTM for both debt issues. The YTM can be calculated with the use of Rate function/formula of EXCEL/Financial Calculator. The function/formula for Rate is Rate(Nper,PMT,-PV,FV) where Nper = Period, PMT = Coupon Payment, PV = Current Selling Price of Bonds, FV = Face/Par Value of Bonds

_______

YTM of First Debt Issue

Here, Nper = (30 - 5)*2 = 50, PMT = 1,000*8%*1/2 = $40, PV = 1,000*92% = $920 and FV = $1,000 [we use 2 since the bond is semi-annual]

Using these values in the above function/fornula for Rate, we get,

After-Tax YTM of First Debt Issue = Rate(50,40,-920,1000)*2*(1-34%) = 5.81%

_______

YTM of Second Debt Issue

Here, Nper = 5, PMT = 0, PV = 1,000*73% = $730 and FV = $1,000 [the bond is assumed to be annual bond]

Using these values in the above function/fornula for Rate, we get,

After-Tax YTM of Second Debt Issue = Rate(5,0,-730,1000)*(1-34%) = 4.29%

_______

Now, we can calculate after-tax cost of debt as follows:

Best Estimate of After-Tax Cost of Debt = Market Value of First Debt Issue/(Total Market Value of Debt)*(YTM of First Debt Issue) + Market Value of Second Debt Issue/(Total Market Value of Debt)*(YTM of Second Debt Issue)

Using the values calculated above, we get,

Best Estimate of After-Tax Cost of Debt = (18,000,000*92%)/73,500,000*5.81% + (78,000,000*73%)/73,500,000*4.29% = 4.63%

Related Questions

Navigate

• Browse (All)
• Browse J
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.