Question

CCC Company currently does not use any debt at all (it is an all-equity firm). The firm has 1,000,000 shares selling for $40 per share. Its beta is 0.6, and the current risk-free rate is 2%. The expected market return for the coming year is 14%. CCC Company will sell $20,000,000 in corporate bonds with a $1,000 par value. The bonds have a yield to maturity of 10%. When the bonds are sold, the beta of the company will increase to 0.8. CCC will use the entire proceeds of the bond sale to repurchase an equal dollar amount of its equity (buyback shares). The corporate tax rate is 25%. 1. What is the WACC of CCC Company before the bond sale? Enter using the %, for example if you obtain 0.20 then enter 20%. A 2. What is the market value of debt after the bond sale? Do not use dollar sign. Round to the nearest dollar. Use commas to separate thousands. A 3. What is the market value of equity after the bond sale? Do not use dollar sign. Round to the nearest dollar. Use commas to separate thousands. A 4. What is the weight for equity in the capital structure (the value E/V) - used to compute the WACC? Enter using the %, for example if you obtain 0.20 then enter 20% A 5. What is the cost of debt after the bond sale? Enter using the % and TWO decimal places, for example if you obtain 4.20% then enter 4.20% A 6 What is the cost of equity after the bond sale? Enter using the % and TWO decimal places, for example if you obtain 4.20% then enter 4.20% Ą, 7. What is the adjusted WACC of Chiquitica Company after the bond sale? Enter using the % and TWO decimal places, for example if you obtain 4.20% then enter 4.20%

Answer 1

1) Before bond sale, WACC = Cost of equity = Rf + beta x (Rm - Rf) = 2% + 0.6 x (14% - 2%) = 9.2%

2) Market Value of debt = $20 million

3) Market Value of equity = $40 x 1m - $20 = $20 million

4) Weight of equity = 20 / (20 + 20) = 50%

5) Cost of debt = YTM = 10%

6) Cost of equity = 2% + 0.8 x (14% - 2%) = 11.6%

7) WACC = 50% x 10% x (1 - 25%) + 50% x 11.6% = 9.55%