Chiquitica Company currently does not use any debt at all (it is an all-equity f
ID: 2789077 • Letter: C
Question
Chiquitica Company currently does not use any debt at all (it is an all-equity fim). The firm has three million shares selling for $42 per share. Its beta is 1.1, and the current risk-free rate is 3.4%. The expected return on the market for the coming year is 11.1%. Chiquitica Company will sell $42,000,000 in corporate bonds with a $1,000 par value. The bonds have a yield to maturity of 9%. When the bonds are sold, the beta of the company will increase to 1.5. 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. What was the WACC of Chiquitica Company before the bond sale? % (Round to two decimal 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
Answer ) WACC of of Chiquitica company before slae of debt is equal to cost of equity i.e
Cost of equity = Rf + Beta * (Rm-rf)
= 3.4% + 1.1*(11.1%-3.4%) = 11.87%
or WACC before Sale of bond =11.87%
Answer 2)
Total equity before debt = 3000000 x 42 = 126,000,000
Total Debt = 42000000
total equity after debt issuance = 126,000000-42000000 = 84000000
cost of equity levered =
unlevered cost of equity + debt / equity * (unlevered cost of equity - cost of debt) * (1-tax rate)
= 11.87% + 42000000/84000000 * (11.87%-9%) *(1-0.20)
=13.018%
WACC after debt issuance = Weight of equity * cost of equity + weight of debt * after tax cost of debt
Weight of debt = 0.33333
Weight of equity =1-0.3333 =0.66667
Cost of equity = 13.018%
Before tax Cost of debt = 9%
WACC = 0.09*(1-0.20) * 0.33333+ 0.13018*0.66667 =0.110787 or 11.07%
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