TGB Factual is an investment bank that is structuring a debt

TGB Factual is an investment bank that is structuring a debt issue for Solar, a company active in the beverage production and distribution segment. Solar is totally unleveraged and TBG estimates that, in addition to the NPV of the new ones that will be deployed with funding, debt collection can benefit the company by reducing its weighted average cost of capital (WACC). Solar\'s current WACC is 11.2% nominal US $ per year. Considering that at the time of the analysis the US risk free rate is 4.3% per year, the premium for the Brazilian parent risk is 1.7% per annum and the US market risk premium is 5.5 % per year, what would be the new WACC in nominal US $ for the beverage industry. Consider a tax rate (T) of 34% and a D / E ratio of 0, 5 after the issue of the debt.

Solution

Current WACC is 11.2% which is effectively cost of equity since there is no debt.

Proposed debt cost = risk free rate + market risk premium + parent risk which is (4.3% + 5.5% + 1.7%) = 11.50%. The post tax cost will be 11.50 * (1-34%) = 7.59%

At D/E of 0.5, we will have weight got debt at 1/3 and equity at 2/3, hence the WACC after the issue will be : (7.59% * 1/3 + 11.2% * 2/3) = 10%