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Liu Industrial Machines issued 152,000 zero coupon bonds five years ago. The bonds originally had...

Question:

Liu Industrial Machines issued 152,000 zero coupon bonds five years ago. The bonds originally had 30 years to maturity with a yield to maturity of 7.2 percent. Interest rates have recently increased, and the bonds now have a yield to maturity of 8.3 percent. If the company has a $46.7 million market value of equity, what weight should it use for debt when calculating the cost of capital? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

Market Value of the Firm:

A firm funds its assets from various sources such as debt (bonds) and equity. Each source has its own cost and the weight of each source is the market value of that source as a fraction of market value of the firm. The cost of capital is the weighted-average cost of all the sources of funds.

Answer and Explanation:

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  • weight of debt would be 0.3072

calculating the market price of the bond:

  • Let the face value of bond be $1,000

As the bond is zero coupon, so there...

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Capital Structure & the Cost of Capital

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Chapter 15 / Lesson 1
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In this lesson, we'll define capital and a firm's capital structure. We'll also discuss the costs associated with each component in the capital structure and learn about the concept of risk and return.


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