Question

Jiminy’s Cricket Farm issued a bond with 30 years to maturity and a semiannual coupon rate of 6 percent 4 years ago. The bond currently sells for 105 percent of its face value. The company’s tax rate is 23 percent. The book value of the debt issue is $60 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 8 years left to maturity; the book value of this issue is $35 million, and the bonds sell for 67 percent of par.

a.

What is the company’s total book value of debt? (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567.)


b. What is the company’s total market value of debt? (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567.)

c. What is your best estimate of the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Step-by-step explanation:

a.)

The total debt amount in Jiminy's Cricket Farm's balance sheet on the liabilities side is referred to as the book value of debt. It is calculated by be the summing up of the individual book values of the two bonds that this company has.

Total book value ;

Book value of 30 year bond = $60,000,000

Book value of the Zero-coupon bond = $35,000,000

Total book value of debt = $60 + $35 = $95,000,000

b.)

The sum of market values of the two bonds this company makes up the total market value of debt. It is calculated by multiplying the current price of the bond by the number of outstanding bonds.

Formula for market value = Price * number of bonds

30 year bond;

Number: 60,000,000/1000 = 60,000 bonds

Market value = 1.10 * 1000 *60,000 = $66,000,000

Zero-coupon bond;

Number: 35,000,000/1000 = 35,000 bonds

Market value = 0.67 * 1000 *35,000 = $23,450,000

Total market value of debt = $66,000,000 + $23,450,000 = $89,450,000

c.) Companies who have debt in their capital structure benefit from tax shield on their debt interest rates . Jiminy’s Cricket Farm has two bonds, find the average of the two rates to get after tax cost of debt.

Calculate the Pretax cost of debt first. Using a financial calculator, input the following;

30 year bond;

N = 30*2 = 60

PV = -$66,000,000

PMT = (6%/2)* $60,000,000 = $1,800,000

FV = $60,000,000

then compute semiannual rate; CPT I/Y = 2.664%

Convert to annual rate = 5.329% (this is the pretax cost of debt)

Zero-coupon bond;

N = 8

PV = -$23,450,000

PMT = 0

FV = $35,000,000

then CPT I/Y = 5.133% (this is the pretax cost of debt)

Next, find the average pretax cost of debt = (5.329% + 5.133%) /2 = 5.231%

After tax cost of debt = pretax cost of debt (1-tax)

After tax cost of debt = 5.231% (1-0.23) = 4.03%