Bennington Industrial Machines issued 152,000 zero coupon bonds five years ago.

Question

Bennington Industrial Machines issued 152,000 zero coupon bonds five 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.   

1. What is the price of the bonds? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

2. What is the market value of the company's debt? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

3. If the company has a $46.7 million market value of equity, what weight should it use for debt when calculating the cost of capital?

Explanation / Answer

1. Let the par value be $1,000 of each bond. The current time = end of the 5th year or the beginning of the 6th year. Time left till maturity = 30 years - 5 years = 25 years.

Price of the bond = par value/(1+new YTM)^number of years

= 1,000/(1.083^25) = $1,000/7.17 = $139.42. This is the price of a single bond.

2. market value of the company's debt = price of a single bond*number of bonds = $139.42*152,000 = $21,191,518.06

3. market value of equity = $46.7 million. market value of debt = $21,191,518.06 or $21.19 million

Total value of capital = equity+debt = 46.7+21.19 = $67.89 million.

weight = value of debt/value of capital = 21.19/67.89 = 31.21%

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