Question

In order to accurately assess the capital structure of a firm, it is necessary to convert its balance sheet figures from historical book values to market values. KJM Corporation's balance sheet (book values) as of today is as follows: Long-term debt (bonds, at par) $23,500,000 Preferred stock 2,000,000 Common stock ($10 par) 10,000,000 Retained earnings 4,000,000 Total debt and equity $39,500,000 The bonds have a 7.0% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 11%, so the bonds now sell below par. What is the current market value of the firm's debt? $17,436,237 $17,883,320 $18,330,403 $17,706,000 $17,898,650

Answer 1

Answer:

The MV of Debt is $17,883,320.

Explanation:

The answer to this question involves three step process.

Step 1) Calculate the Price of Each Bond

You must have known that when we discount the future cash flows of bond, that is coupon payments and Face value, we get the Price of that Bond. You will get the price of each bond to be $760.99. I have attached an Excel Sheet, it will help you to understand.

Note: Remember to consider YTM and Number of Periods on Semi-Annual Basis because the coupon payments are to be made Semi-Annually.

Step 2) Determine the Number of Bonds

We know that

     Value of Debt (23,500,000) = Par Value (1,000) * Number of Bonds (x)

Rearrange the equation for Number of Bonds and you will get 23,500.

Step 3) Market Value of Debt

Simply multiply the Price of Each Bond with the Number of Bonds and the answer is $17,883,320.

Thanks!

Download xlsx