IMPORTANT!! The answer is not 34.2982, 0.3430, or 34.30 The answer is not 34.298
ID: 2786974 • Letter: I
Question
IMPORTANT!! The answer is not 34.2982, 0.3430, or 34.30
The answer is not 34.2982, 0.3430, or 34.30
The answer is not 34.2982, 0.3430, or 34.30
Bennington Industrial Machines issued 155,000 zero coupon bonds four years ago. The bonds originally had 30 years to maturity with a yield to maturity of 5.9 percent. Interest rates have recently increased, and the bonds now have a yield to maturity of 6.7 percent. Required: If the company has a $55 million market value of equity, what weight should it use for debt when calculating the cost of capital? (Do not round intermediate calculations. Round your answer to 4 decimal places (e.g., 32.1616).) 34.30 CExplanation / Answer
I think you are computing the answer with annual YTM. Zero-coupon bonds do not pay interests but they have implied interests as they are issued on a discount. These implied interests are usually computed using semi-annual compounding convention. So, instead of 6.7% YTM, you need to take 6.7%/ 2 and instead of 26 periods, you need to take 26 x 2 periods.
Assuming $1000 face value of bonds redeemable at par, market price is calculated as follows -
Market Value = $1000 / (1 + 0.067/2)2 x 26 = $180.241581739 per bond
Total market Value of bonds = $180.241581739 x 155,000 = $27,937,445.1695
Total market value of firm = $55,000,000 +$27,937,445.1695 = $82,937,445.1695
Weight of debt = $27,937,445.1695 / $82,937,445.1695 = 0.33684959926 or 0.3368 or 33.68%