Chiquitica Company currently does not use any debt at all (it is an all-equity f

Question

Chiquitica Company currently does not use any debt at all (it is an all-equity firm). The firm has three million shares selling for $40 per share. Its beta is 1.3, and the current risk-free rate is 3.6%. The expected return on the market for the coming year is 9.4%. Chiquitica Company will sell $40,000,000 in corporate bonds with a $1,000 par value. The bonds have a yield to maturity of 1 1%. When the bonds are sold, the beta of the company will increase to 1.6. What was the WACC of Chiquitica Company before the bond sale? What is the adjusted WACC of Chiquitica Company after the bond sale if the corporate tax rate is 20%? Hint: Start with the capital structure of an all-equity firm and then figure out how it changes with the bond sale and how the procees from that sale are used. 1% Round to two decimal What was the WACC of Chiquitica Company before the bond sale? places.) What is the adjusted WACC of Chiquitica Company after the bond sale if the corporate tax rate is 20%? % (Round to two decimal places.)

Explanation / Answer

WACC before bond sale will be equal to cost of equity
Using CAPM:
rate = 3.6+1.3(9.4-3.6)=11.14%

Adjusted WACC:

Total capital = 120+40=160
Weight of equity = 120/160=0.75
Weight of debt =0.25

using CAPM
Cost of equity = 3.6+1.6(9.4-3.6)=12.88
Cost of debt = 11*(1-0.2) adjusting for tax= 8.8
Taking weighted average

Weight Cost Equity 120 0.75 12.88 9.66 Debt 40 0.25 8.8 2.2 WACC 11.86

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