Question

Jiminy’s Cricket Farm issued a bond with 25 years to maturity and a semiannual coupon rate of 4 percent 3 years ago. The bond currently sells for 108 percent of its face value. The company’s tax rate is 22 percent. The book value of the debt issue is $30 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 10 years left to maturity; the book value of this issue is $15 million, and the bonds sell for 73 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

The total book value of debt is $45 million, and the total market value of debt is $43.35 million. To estimate the aftertax cost of debt, we calculate the tax-adjusted interest expense using the assumed market rate and the tax rate for the coupon bond, but exact calculations for the zero coupon bond would require additional details on market yield.

Step-by-step explanation:

To calculate the total book value of debt for Jiminy's Cricket Farm, we simply add the book value of both debt issues. The first debt issue has a book value of $30 million and the second, a zero coupon bond, has a book value of $15 million. Therefore, the total book value of debt is $30 million + $15 million = $45 million.

Next, when assessing the total market value of debt, we consider the current market prices of the bonds. The first bond sells at 108% of its face value, so the market value for the first issue is $30 million ×108% = $32.4 million. The second bond, a zero coupon bond, sells for 73% of par, so its market value is $15 million ×73% = $10.95 million. Thus, the total market value of debt is $32.4 million + $10.95 million = $43.35 million.

For the aftertax cost of debt, we consider the effective after-tax interest expense relative to the market value of the debt. Assuming the semiannual coupon bond has a market interest rate similar to the coupon rate (since it sells at a slight premium), we would expect the before-tax cost of debt for this bond to be close to 4% semiannually, which is 8% annually. Thus, the aftertax cost of debt is 8% ×(1 - 0.22) to account for the 22% tax rate. For the zero coupon bond, without specific market yield information, we could estimate its yield based on current pricing and maturity, but we lack the required details to make this calculation. Therefore, for this exercise, we will not attempt an exact calculation but note that the combined cost of debt will be a weighted average of the two issues, adjusted for the tax rate.

Answer 2

Step-by-step explanation:

a.What is the pre-tax cost of debt?This question is basically asking for the bond’s current yield to maturity, which is the pre-tax cost of long term debt in the capital markets for this company today.Price = 1.08 * 1000 = 1080+/- PV23 * 2 = 46 N.10 * 1000 = 100 / 2 = 50 PMT1000 FVSolve for i/y = 4.5801 is the semi-annual yield to maturity * 2 = 9.1601% annual YTM

b.What is the after-tax cost of debt?9.1601 * (1 - .35) = 5.9541 after tax cost of debt.This is the true cost of debt to the company because the company gets a tax deduction (a tax shield!) for paying interest on its debt.