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 $41 per share. Its beta is 0.7, and the current risk-free rate is 3.9%. The expected return on the market or the coming year is 96% Cna tica Company will sell 41 000000 orporate bond witha $1,000 par value. The bonds have a yield to maturity of 12%. when the bonds are sold, the beta of the company will increase to 1.2, 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 15%? 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 WAC of Chiqui ca Company after the bond sale if the corporate tax rate is 15%? % Round to two decimal places.

Explanation / Answer

a) Using CAPM, Cost of equity = Rf + beta x (Rm - Rf) = 3.9% + 0.7 x (9.6% - 3.9%) = 7.89%

Before the bond sale, WACC = Cost of equity = 7.89%

b) Market Value of equity = No. of shares x Share Price = 41 x 3 = 123 million

Market Value of debt = 41 million

WACC = wd x kd x (1 - tax) + we x ke

here, wd - weight of debt = 41 / (41 + 123) = 25% , kd - cost of debt = YTM = 12%, tax = 15%, we - weight of equity = 1 - 25% = 75%, ke - Cost of equity = 3.9% + 1.2 x (9.6% - 3.9%) = 10.74%

=> WACC = 25% x 12% x (1 - 15%) + 75% x 10.74% = 10.61%

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