Question

Ace Industrial Machines issued 195,000 zero coupon bonds four years ago. The bonds originally had 30 years to maturity with a yield to maturity of 5.2 percent. Interest rates have recently decreased, and the bonds now have a yield to maturity of 4.9 percent. If the company has a $73 million market value of equity, what weight should it use for debt when calculating the cost of capital

Answer 1

Answer:

Coupon (R) = 0

Face value = $1,000

Years to maturity (n) = 30 years

Kd = 4.9% = 0.049

Po = R(1-(1+Kd)-n)/kd + FV/ (1+Kd)n

Po = 0(1-(1+0.049)-30/0.049 + $1,000/(1+0.049)30

Po = 0 + $238

Po = $238

                                                                        $

Market value of equity                                = 73

Market value of bond (195,000 x $238)    = 46.41

Market value of the company                       119.41

Weight of debt  = 46.41/119.41  x 100

Weight of debt = 38.87 = 39%

Explanation:

In this case, there is need to calculate the current market value of bond, which is the present value of coupon and the present value of face value of the bond. Then, we will calculate the market value of the company, which is the aggregate of market value of equity and market value of bond.