Bennington Industrial Machines issued 151,000 zero coupon bonds four years ago.

Question

Bennington Industrial Machines issued 151,000 zero coupon bonds four years ago. The bonds originally had 30 years to maturity with a yield to maturity of 7.1 percent. Interest rates have recently increased, and the bonds now have a yield to maturity of 8.2 percent.

If the company has a $46.6 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).)

Bennington Industrial Machines issued 151,000 zero coupon bonds four years ago. The bonds originally had 30 years to maturity with a yield to maturity of 7.1 percent. Interest rates have recently increased, and the bonds now have a yield to maturity of 8.2 percent.

Explanation / Answer

The weight of debt should be based on the current market value of the zero copon bonds which is fiven by:

Market Value = face Value/(1+r)^n where Face value = 151,000*1000 = 151,000,000

r=0.082= 8.2%, and n = 30-4 = 26 years

Hence Market Value = 151,000,000/(1+0.082)^26 = $19,456,654.51

Value of equity = $46,600,000.

hence total equity + debt =  $19,456,654.51 +  $46,600,000. = $66,056,654.51

Hence weight of debt = $19,456,654.51/$66,056,654.51 = 0.2945

hence weight of debt =0.2945

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